39-40 Covered Warrants Dec 10 18/11/10 17:14 Page 39

Warrants, covered!

Despite a versatility that provides the ability to either profit from or insure against market , covered warrants remain unfairly underappreciated, as Oliver Haill discovers

ince their launch in the UK in 2002, use by risk-conscious private investors. money you invest with them if you have a covered warrants have been slow to ‘Covered warrants are effectively options call. However, the amount you can take off, with London’s 1,500 or so repackaged for private investors – they are lose with a covered is limited to Scovered warrants being dwarfed by the tens of more transparent and more liquid as they the amount you invest.’ thousands listed on other markets such as the are listed on the London Exchange,’ This low risk profile makes them very Deutsche Börse and in Hong Kong. says Andrew McHattie, editor of the attractive to some investors: they still give Perhaps it is a British suspicion of Warrants Alert newsletter. you similar geared returns to spread bets, anything invented in France, that cradle of ‘When the market was launched in the but you know that you won’t be asked for capitalism, as these products were UK, the FSA was very keen to ensure that more money if your call goes the wrong in 1989. Perhaps it is the tax-free attractions the risks were limited, and so the amount way – you won’t get a call in the morning of rival products such as spread bets and you can lose is limited,’ he adds. from your broker saying that you’ll need to contracts for difference (CFDs). Or perhaps sell your house. they just sound too complicated – the sort Limited losses Moreover, unlike options, covered of thing in which only men in red braces Indeed, this is the crucial dissimilarity from warrants are listed on the should dare dally. rival products. Société Générale (SocGen) and can be bought and sold through your While all of these reasons may be is the company that invented covered normal broking account. justifiable to some degree – apart from warrants and one of only two issuers in the Ben Board, director of RBS listed possibly the distrust of the French – they UK, along with RBS. investments, says the LSE listing means are only stopping investors from taking Alexandre Houpert, head of exchange- covered warrants are a very liquid market. advantage of a versatile, powerful product. traded products for SocGen, explains, ‘The He says, ‘We are obliged to provide a Not only that, but unlike , it main difference is that with spread betting two-way market and tight spreads. It gives is a product that was designed expressly for and CFDs you can lose more than the investors confidence that they don’t have to

www.WhatInvestment.co.uk 39 39-40 Covered Warrants Dec 10 18/11/10 17:14 Page 40

hold the warrant until . If they’ve Speculating or hedging buy a “put” on the FTSE to insure against made an investment decision and it’s going The experts all agree that there are three your equity holdings, your shares will be all the right way and making money, then main strategies that investors can put in right if the market increases but you will lose they can sell it and crystallise that gain. place though covered warrants. Due to the the money spent on the warrant. However, if Alternatively, if it looks like they are going gearing effect – whereby a small movement the market down then the warrant will make to lose on that decision, they can sell out in the underlying asset produces a much money and compensate the losses you make and minimise any loss.’ larger movement in the warrant – most on your UK equity portfolio.’ private investors use covered warrants for A more conservative way of using the How they work making speculative bets on the market, as in gearing effect is cash extraction. This allows Ironically, it is this gearing effect that the FTSE call above. you to use the gearing effect to replicate an makes covered warrants so effective, ‘In spread betting and CFDs the gearing is existing underlying equity position as well as but also is what creates the veneer fixed,’ says McHattie, ‘but with the covered extracting most of your cash, which sounds of complexity that puts off many warrant market you can look for gearing too good to be true but is commonly used. potential investors. levels to suit you. A speculative investor is Houpert explains, ‘If you had a £1,000 However, you don’t need to understand position in British Land and you wanted to the intricate financial mechanism ‘inside’ secure your gain then you could sell all your the covered warrant in order to see how ‘Covered warrants are effectively equity and buy a covered warrant. they function on the surface. Simply, a options repackaged for private ‘Say the covered warrant had a gearing covered warrant is just a contract for an effect of ten. You could sell all your shares, investor to buy or sell an underlying investors – they are more put just £100 into a covered warrant and the – such as a share or a commodity – transparent and more liquid’ rest into a savings account. As the covered at a particular price and by a particular date. warrant’s gearing effect gives £1,000, you will The new nomenclature might be all Greek make the same gains [as you would have on to you – call, put, strike and even delta and looking for big movements, so might be your previous equity position], and if you gamma – but they all mask simple actions going for a gearing level of eight or ten lose then you only lose £100 and you still and are easy to learn over time. times, while a more conservative investor can have the £900 to do with as you will.’ Board explains, ‘Call warrants are for choose gearing of two or three times.’ when you want exposure to a rising market RBS and SocGen both find that private Spice of life while put warrants give you exposure if investors seem to be more interested in the The variety on offer, even though the you think that asset will fall. The strike speculative aspect, while professional investors options are relatively small compared with price is the level above which, for a call tend to trade for hedging or cash extraction. other markets overseas, is still wide. Investors warrant, the underlying asset has to be in However, hedging is a simple process and can choose between investing in warrants on order for you to make money.’ offers an excellent means of ‘insuring’ a equities; hard commodities such as gold, So, where an investor buys a covered portfolio of blue-chip . It should also silver and copper; soft commodities like corn warrant on the FTSE 100 with a strike prove particularly tempting to those for and wheat; foreign exchange relationships price of 6,000 points and a maturity date of whom the possibility of a double-dip between most of the major currencies; December 2010, Board says, ‘The FTSE recession weighs heavily on the mind, too. indexes such as the FTSE and S&P; and would have to climb above 6,000 points for ‘If you have a portfolio of UK-listed stocks, exchange-traded funds. you to make money. But in fact you could you could take out a put covered warrant on The SocGen warrants website – crystallise a gain even before it hits 6,000 the FTSE 100 as a sort of insurance cover uk.warrants.com – is a useful information as the price of the covered warrant will on this,’ says Houpert. resource and has a nifty ‘simulator’ trading move further ahead due to the gearing. If ‘Like with insuring a house or a car, you tool in which you can plug in your you are in the money at maturity then would pay a premium, so the price of the predictions and it will tell you which you’d get a cash payment.’ covered warrant is the premium. So if you warrant will make you the most money. N

40 www.WhatInvestment.co.uk