SINGAPORE is becoming one of the major warrants markets in Asia, with the volume of warrants traded growing dramatically since 2004. In the past six months, the average monthly trading volume was over $1 billion, more than five times the amount traded in the same period two years ago. We take a look at the increasing popularity of put warrants and index warrants as well as trading trends.
After the recent dip in the Singapore market in May this year, put warrants rose in popularity as investors realised that there were just as many opportunities to profit from downward moves as there are on the upside.
So what are put warrants?
Put warrants allow investors to potentially earn a profit when an underlying share price falls. Unlike call warrants that move in the same direction as the underlying share price, put warrants actually increase in value as the underlying share price falls and decrease in value as the underlying share price rises.
Put warrant turnover has improved dramatically over the past year, increasing from less than 2 per cent to 24 per cent of total warrant turnover over the past year. This ratio is likely to increase further as more investors learn about the advantages of put warrants.
Put warrants can be used by investors who have a negative view on a stock price and want to profit from it. This is called directional trading.
Put warrants can also be used as insurance against potential losses for an existing holding, also known as hedging.
Say you have a large holding in a particular share and are concerned that the share price may fall in the short term but do not want to sell your holding. You can use put warrants to protect your position against a potential fall. If the share price does fall, the put warrant is likely to increase in value and the profit you make on your put warrant holding will partially offset (depending on how many put warrants you buy) the losses you sustain on your stock holding.
Another way to take a negative position in a warrant is by short selling a call warrant (shorting means selling something that you do not hold with the intention of buying it back at a cheaper price).
There are two major advantages of buying a put warrant over 'shorting' a call warrant. Firstly, if an investor buys a put warrant, the potential losses are limited to the price paid for the warrant. If an investor shorts a warrant, the potential losses can be unlimited as the warrant could potentially keep rising in price.
Secondly, if an investor shorts a warrant, he has to close the position by the end of the trading day or face a forced buy-in by the Singapore Exchange (SGX). Put warrants enable investors to hold a position and potentially profit from further falls for as long as the warrant is listed.
The Singapore stock market has seen extreme volatility in recent times due to the uncertainty in global markets. Index warrants are well suited to a volatile environment. Over the past year, index warrants have risen from 8 per cent to 38 per cent of warrant turnover.
Index warrants allow investors to get exposure to the market as a whole, removing the need to select individual stocks.
In principle, they are generally less risky because the index tends to be less volatile than individual shares. For example, the Singapore share index will rarely move more than 2 per cent in a day, whereas single stocks can sometimes move more than 10 per cent as we have seen this year.
Index warrants are available as both call and put warrants, so during volatile times investors are able to profit from both rises and falls in the market. For example, if you have a bullish view on the Singapore market and want to get a leveraged exposure to potential upside without committing too much capital, you can buy a call warrant over the Singapore MSCI index. Then, if the index rises, you will likely be able to sell your warrant back at a profit.
Another way to use index warrants is for a strategy called hedging. This is when an investor thinks that the market is looking too expensive and is concerned that a correction may be coming. You could say that the investor is bearish for the short term. However, he may not want to sell his portfolio, as he believes the market will continue to rise over the longer term. He could instead purchase some index put warrants to partially protect his position.
If the market does fall, the potential gain on the index warrants should partially offset the unrealised losses in his portfolio.
Index warrants also offer investors the ability to access foreign markets.
Currently, in Singapore, you can trade index warrants over Singapore, Japanese and Hong Kong indices, to name a few, enabling you to trade movements in these markets without needing to select individual stocks or transact on a foreign stock exchange. Index warrants have been in the spotlight, specifically those of the major Hong Kong benchmark, the Hang Seng Index.
Singapore investors this year have preferred to trade foreign listed indices such as the Hang Seng and Nikkei. One major reason is that they have more liquid underlying futures markets than the Singapore MSCI index (SiMSCI) futures, and hence are able to offer more liquid index warrants.
This will hopefully change in the future with the SGX proposing to tighten minimum stock spreads in Singapore which will likely increase activity in the index futures and hence index warrants.
Early 2006 saw a rise in popularity of China-related stocks and warrants. However, with many of these volatile China stocks suffering big falls in the May shakeout, the focus has returned to the blue chips.
Over the past quarter, the rise in the market has been led by a small number of blue-chip stocks and so has the interest in the warrant market. In the past nine months, the most active warrants have been CapitaLand, DBS and Hang Seng Index warrants.
The property sector has been very popular. Keppel Land and City Developments have featured in this sector. However, interest has been concentrated in CapitaLand, which has dominated the warrants market since early 2005. Its high liquidity and volatility have provided opportunities for traders and investors alike, with the stock rising more than 30 per cent since its low of $3.86 in June to trade over $5.
The banking sector has also been popular among warrant participants. Warrants over UOB, OCBC and DBS often feature among the daily top traded warrants. DBS warrants have dominated this sector as its share price tends to be more volatile and hence provides more opportunities for traders. The banking sector has also performed well since the falls earlier in the year, with DBS rising more than 25 per cent from its lows in June.
Another sector that featured this year was the offshore and marine sector. High volatility and rising oil prices were the catalyst for this, with Labroy Marine and Cosco warrants being the most popular.
The writer is associate director, head of warrants, Macquarie Securities (Singapore) Pte Ltd
