Thursday June 21, 12:00 PM
How covered warrants work
By Sam Barrett
If you like the idea of gearing but don't want to lose more than you invest then covered warrants might be worth considering. Like spread bets and contracts for difference you can ratchet up your market exposure while enjoying
more control over your losses.
Covered warrants are financial instruments that give you the right, but not the obligation, to buy or sell an asset at a set price on, or before, a set date. They were introduced to the UK in October 2002, are issued by financial institutions such as Goldman Sachs, SG Warrants and JP Morgan and are traded on the stockmarket.
The way they work is similar to options but the typical lifespan of a covered warrant is longer. Most are between six and 12 months, although some can last as long as two years.
But although they have these fixed lives, most investors don't hold them until expiry, preferring to take their profits or losses by trading them or exercising them before this date. However, there's nothing to stop you holding them until they expire. If you are still holding one beyond its expiry date it will be exercised automatically, with the proceeds credited to your account.
The price that you will pay for a covered warrant is affected by a couple of factors as Richard Miller, manager of active trading at Barclays Stockbrokers, explains: "Their value is affected by the intrinsic value, which is the difference between the current value of the underlying asset and what you can buy or sell it at through the warrant, known as the strike price. The more money you could make the more expensive the warrant will be. Time is the other factor as the nearer you get to the expiry date the less time there is for things to change."
Although the majority of covered warrants are available on blue chip companies, you can also access a wide range of assets through them. These include indices, baskets of shares, the housing market, currency and commodities such as gold and oil.
The big risk with covered warrants is that you could lose everything if the value of the underlying asset doesn't exceed the strike price plus the price of the warrant.
But while you can lose everything you invest, you'll never lose more than that. "This is better than using instruments like spread bets or contracts for differences (CFD) where you can lose more than your original investment if you get it wrong, but some people don't like the all-or-nothing approach," says Miller.
Additionally, unlike spread betting and contracts for difference, there are no margin calls so you won't need additional money to finance your investment.
A variant of the covered warrant is the stop-loss warrant, which is also known as a listed contract for difference. "These incorporate a guaranteed stop and will automatically close a position out if the value of the underlying asset hits a set level. This means they are slightly cheaper than covered warrants," explains Miller.
Trading covered warrants
Covered warrants can be traded in a standard share dealing account or held within a self-invested personal pension wrapper (SIPP). This means that charges are generally the same as for trading shares.
For instance Barclays Stockbrokers charges £12 but reduces this to £7.50 if you trade more than 10 times a quarter.
As you don't own the underlying asset there is no stamp duty to pay when you trade covered warrants, but they are subject to capital gains tax on the proceeds.
|
Send Article by Email
Send Article by IM
Blog This with Y! 360
Printable View
