Friday, December 28, 2007

How to play Call Warrant?

When I told one of my friends that I was doing analysis on Call Warrants, he told me that it was better to go to Genting Highland to gamble using probability. Well, I did not agree with him as the following reasons:-

1. Most games in Genting Highland, you are playing against the house. The boss of Genting Highland might uses millions of dollars to hire experts to design a system to make sure that your chances of winning are greatly reduced.
2. On the other side, buying call warrants is you are playing against all ordinary people which I believe less than 30% are exactly know what they are doing. The rest are just the followers.

People say Call Warrant is a risky investment vehicle. There is no doubt it is risky when you buy it when you know nothing about it. It is more risky if you buy it when you have a little knowledge about it (A little knowledge is more dangerous than no knowledge).

In my opinion, to start off with the Call Warrant, you will need to understand a few basic things:-
1. Maturity/ Expire date for Call Warrant
2. Exercise price
3. Premium or Discount of the current Call Warrant Market price

Please refer to my other post for information (Malaysia Warrants and Call Warrants)

The above 3 items are the most basic that a Call Warrant player MUST understand. The next thing that someone needs to learn is his/her own risk appetite or risk tolerance. The rule of thumb:- Only invest the money that you can afford to lose.

For example, My friend and I bought SINOPEC-C1 2 weeks ago and we earn money from it. We came to the decision to buy after doing some analysis.
What we have done?
1. Comparing the Market price of Call Warrant and found it was at 3 cents discount.
2. We knew the maturity date was near (1 month)
3. We knew the mother share very well, it was an Oil and Gas company. So, we would expect that its price might be a bit volatile and the changes of the oil price might move the share price.

Our risk Tolerance:-
1. Since the maturity of SINOPEC-C1 was near, we will not give it much room.
2. The Mother share was HKD 11.98 at the time we bought the SINOPEC-C1 at RM0.23( 2 cents discount). We calculated our risk as below.
Refer to my other post on Intrinsic value of SINOPEC-C1,

The intrinsic value of SINOPEC-C1 should be as below:-
Let RM 1 = HKD 2.34.
Exercise price = HKD 9.00
Entitlement Ratio = 5:1
(HKD 11.98 - HKD 9)/ 5 /2.34= RM 0.2547 (Each of the warrants worth about RM 0.25, 3 cents discount).

We assume that the mother share will drop the day after we bought. What will be the price of the mother share if we were to break even on the Call Warrant.

RM0.23 = (HKD BE - HKD 9) /5 / 2.34
HKD BE = (RM 0.23 * 2.34 * 5) + HKD 9
BE = HKD 11.691

So, our break even point was at about HKD 11.70.
HKD 11.98 - HKD 11.70 = HKD 0.28 (2.34%), From here, we have the risk for the mother share to drop more than HKD 0.28 or 2.34%.

We have closely monitor the mother share of the day we bought and the next day and luck was on our side as the mother share was bullish on those 2 days. The oil price was going up also on those 2 days.

If you were to ask me how to play Call Warrant?
It is all depends on your Risk Tolerance and your Expectation of Return. In our SINOPEC-C1 case, we were able to have the risk for the mother share to drop HKD0.28 ( or 2 cents for each warrant) and we have expected to earn at least 3 cents (by exercise it).

In my next post on Call Warrants, I will compare some of the risky Call Warrants(out of money too much) and some Warrants which are near to their intrinsic values.

1 comment:

lioncor-wa said...

hurmm..i wonder who said go gentingg...