Information
What are Covered Warrants?
Covered warrants are issued by financial institutions and then listed as fully tradable securities on the LSE. A covered warrant gives the holder the right (but with no obligation) to buy or sell an underlying asset, at a specified price, on or before a predetermined date. These versatile instruments, which have already proved popular in other countries, offer a variety of investment solutions for a range of investors.
Types of Covered Warrant
Calls and Puts
There are two basic forms of covered warrant – a Call and a Put. A call is an upbet reflecting a belief that the underlying asset will rise in value during the life of the warrant. A put is the opposite, a downbet reflecting the belief that the underlying asset will fall.
European and American Warrants
Covered warrants can either be European or American style. There is little difference between the two, European style warrants allow you to exercise your right only on on a specific date, while American style permits exercise at any time up to the expiry date.
Stock Warrants
The main focus is on popular UK 'blue-chip' shares such as Vodafone, BP, GlaxoSmithKline, Lloyds TSB and RBS, where there are numerous competing warrants from different issuers.
Basket Warrants
For exposure to a particular theme or sector, a number of securities are sometimes grouped together in a 'basket'. Investors can then obtain exposure to this basket simply and efficiently by buying one single security in the form of a covered warrant.
Index
The most active traded warrants tend to be those on the main domestic market index. In the UK, the FTSE 100 Index has been consistently popular.
Commodity
It can be difficult for private investors to gain exposure in sterling to major commodities such as gold, silver and oil. Using covered warrants it is possible for investors to take positions on these commodities, in small size and in sterling.
Currency
Covered warrants are available on a range of exchange rates, including sterling/dollar, sterling/euro and yen/dollar.
Advantages & Disadvantages
Advantages
- Access to home or international markets.
- Underlying products include equities, indices, commodities and currencies.
- Opportunity to expand your portfolio in new directions without actually buying the underlying products.
- All warrants are 'cash-settled' – the gain achieved on the warrant is transferred to the holder without the holder having to carry out a buy or sell trade.
- Covered warrants do not require margin accounts or margin calls.
- Profits can be made from both falling and rising markets.
- Warrants have over equities is leverage.
Disadvantages
- Not as simple as trading with shares, or even traditional warrants, they are complex and can get confusing.
- The value of a warrant is not just its intrinsic value but also the premium or time value. This premium can on occasions be quite high.
- Roughly a third of a warrant's time value is lost during the first half of its life and two thirds goes in the second half.
- Warrants do not qualify for dividends, which can be a disadvantage, especially as over time dividend income has been a major contributor to the overall return from shares.
- There's no stamp duty to pay on covered warrants, but if you do make a profit you will be liable to capital gains tax.
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