Small investment, large exposure
Warrants are a way for an investor to lock in the price of an
asset now to purchase at some time in the future. They can also be
used to put a deposit on a parcel of shares and pay them off over
There are many different types of warrants available to
investors. Here we look at three common types of warrants: ordinary
warrants, instalment warrants and MINIs; and explain the risks
involved in investing in warrants.
A warrant is a type of
by a bank or financial institution that is traded on the Australian
Securities Exchange (ASX). An ordinary warrant is similar to
an option. It
gives you the right to buy an asset (such as a share), at a set
price (called the strike price), on or before a date in the future
(the expiry date). Options are usually short term (weeks or months)
while warrants can be valid for a long time (years).
Warrants can either be exercised at any time before the expiry
date (these are called 'American exercise') or only on the expiry
date (these are called 'European exercise').
Warrants can be issued for shares, currencies, indexes (domestic and international), exchange traded
commodities. The strike price is usually higher than the current
market price of the asset when it is first traded but is usually
valid for an extended period of time; and some warrants such as
MINIs or perpetual warrants have no expiry dates.
If the price of the asset rises above the strike price, you can
make a profit by exercising (buying the asset) at the lower
warrant price and then selling the asset at the higher market
price. If you do not exercise the warrant it will simply expire,
unused. So with ordinary warrants you can walk away and you will
just lose the initial purchase price.
Call or put warrants
A call warrant gives you the right to buy the underlying asset
so you benefit from an increase in the asset price. A put warrant
gives you the right to sell the underlying asset so you benefit
from falling prices.
Ordinary warrants are mainly used for speculative
trading and are a high risk
investment. Seek professional financial advice
before you invest, to
decide if they are a suitable investment product for you.
Instalment warrants let you buy an investment product such as
shares over a period of time. You make a part payment on the shares
and pay the remaining balance in one or more payments over time.
It's a bit like a lay-by, except you get all the benefits of owning
the shares from day one, such as receiving dividends and franking
An instalment warrant is mainly used for investing. They are a
form of gearing or leverage as you can get
significant exposure for less money than buying the underlying
asset outright. Generally warrants will only be suitable if
you are very confident of the long-term value of the underlying
Money owing on a warrant is treated as a loan and has an
interest component and a borrowing fee. Interest can be prepaid for
the life of the warrant so there may be tax benefits for some
Case study: André's mining shares
wanted to invest in ABC Mining, a large blue chip resources
company. The share price had fallen steadily over the previous few
years but he thought it was only a matter of time until the price
recovered, potentially giving him a healthy profit.
André decided to increase his exposure by buying instalment
warrants. At the time the share price was $28. The first instalment
was $15 (including funding costs) with a final instalment of $14
due 12 months later.
When the second instalment was due, the shares had dropped to
$19. André had bought 1,000 shares, so with the drop in value he
had lost a total of $10,000 on his original investment.
Self-funding instalment (SFI) warrants are a special type of
instalment warrant. Like standard instalment warrants, you make a
partial upfront payment and the issuer lends you the remaining
amount. Once you have made the initial payment, there are usually
no additional repayments to be made until expiry.
Holders of self-funding instalment warrants receive dividends
and franking credits from the underlying shares. The cash dividends
are used to reduce the loan balance instead of being paid to you.
SFIs have interest and borrowing fees that are added to the loan
Investors hope that the dividends will be greater than the
interest and fees, thus reducing the loan balance over time or even
paying the loan off.
MINIs are a type of warrant listed on an exchange that can be
traded over a range of underlying assets such as shares, indices,
commodities and exchange traded funds.
Like ordinary warrants, MINIs allow you to make an upfront
payment and borrow the balance from the issuer, who will charge
interest and borrowing fees.
Unlike other types of listed warrants, MINIs have no set expiry
date and usually track the value of the underlying asset closely.
MINIs do not give you the right to purchase (or sell) the
underlying asset, they only allow you to trade on the movements in
the value of the underlying asset.
MINI warrants are classified as either 'longs' or 'shorts'. A
MINI long allows you to benefit from an increase in the value of
the underlying asset. A MINI short allows you to benefit from
MINIs have an in-built stop loss mechanism which ensures you
cannot lose more than your initial investment.
If an instalment warrant is not listed on a stock
exchange you could lose more than your original
investment. A listed instalment warrant is supported
by a non-recourse loan and has a stop-loss
Risks of warrants
Warrants are complex and high risk investments. There are many
different types of warrants so it's important to look at the
specific risks of each warrant. You will find this information in
disclosure statement (PDS) provided by the warrant issuer
or your financial adviser.
The general risks of investing in warrants include:
- Counterparty risk - A warrant is a contract
between the warrant issuer and you. This means you are exposed to
the risk that the issuer may not meet their obligations under the
warrant, such as providing the underlying security or cash as
- Price risk - Warrant pricing is more complex
than many other securities. It incorporates many variables
including the underlying security or asset, dividends or interest
and the time to expiry. Unless you understand how warrants are
priced, trading them can be very high risk. The price of warrants
is affected by the same market volatility as other traded
- Limited life risk - Most warrants have an
expiry date, which can range from months to years from the issue
date. If the underlying asset price is not above the exercise
price (or below depending on the type of warrant) and you do not
exercise the warrant, it will expire worthless and you will lose
- Leverage risk - Most warrants involve some
amount of leverage. Small changes in the underlying asset can
lead to large changes in the value of the warrant. Leverage can
increase returns, but also increase losses. The higher the
leverage, the riskier it is.
- Liquidity risk - This is the risk that you may
not be able to sell your warrants quickly for a fair price. If the
underlying asset or security is not frequently traded the warrant
on that asset may also lack liquidity. The warrant issuer has a
market making obligation under the ASX Operating Rules that seeks
to minimize this risk.
- Suspension from trading - The exchange on
which the warrant is traded may suspend or remove a warrant from
trading if the issuer does not comply with the exchange operating
rules. A warrant can also be suspended if the underlying share (or
asset) is suspended from trading.
- Time decay - Warrants are decaying assets so
it is important to monitor expiry dates and know when to exercise a
If you are concerned about the risks consider seeking
professional financial advice to help you decide if
warrants are right for you.
To find out more about different types of warrants read the ASX
Trading and Investment Warrants or take their
online warrants and
Warrants are complex investments that can be
used to help build an investment portfolio, if you know what you
are doing. You should find out as much as you can about them before
you invest and seek professional financial advice.
Last updated: 18 Mar 2016