What are warrants?
What are warrants?
A warrant is an instrument that gives the holder a right – but not the obligation - to “buy” or
“sell” an underlying asset at a pre-set price (called the “exercise price”) on or before the expiry
date. Warrants can be issued over a range of assets, including stocks, stock indices,
currencies and commodities or a basket of assets. The list of eligible stocks for warrants over
single stock is posted on the HKEX’s website. However, investing in a warrant does not give
you any rights in or to the underlying asset. Currently, all warrants are cash settled when
exercised on expiry.
There are two types of warrants:
(a) A “call” warrant may be invested in by an investor who believes that the price of the
underlying asset will increase during the term of the warrant.
(b) A “put” warrant may be invested in by an investor who believes that the price of the
underlying asset will decrease during the term of the warrant.
Typically, warrants in Hong Kong are issued with a life span of six months to two years, but
are usually traded by investors before expiry. Warrants magnify your investment through
leverage. This carries significant opportunities as well as significant risks. Warrants usually
cost a fraction of the price of the underlying asset and may provide a leveraged return, but
such leverage could also magnify your losses.
Warrants are a special form of option in which an investor can only take a long position in the
warrants, just like option buyers. This means you can only take a long position in a call or a put
warrant by buying such warrant and close out such long position previously established by
selling such warrant – that is, you cannot short sell such warrant.
Your maximum loss will therefore be limited to the amount you pay for the warrant (plus any
transaction costs, such as broker fees associated with your investment).
How do warrants work?
This depends on the type of warrant you buy (call versus put). The following examples deal
with a warrant linked to a local stock.
(a) Call warrant - At the expiry of a call warrant over a local stock, if the 5-day average
closing price of the underlying stock before the expiry date is:
i. higher than the warrant's exercise price, the warrant is "in-the-money" and will be
exercised automatically at expiry. In that case, you will receive a cash payment
calculated by reference to the positive difference between that 5-day average
closing price and the exercise price of the call warrant, adjusted by the entitlement
ratio; or
ii. equal to or lower than its exercise price, the warrant is “at-the-money” or “out-ofthe-money”, respectively, and will become worthless.
