Forum Archive Index - October 1999

["Nigel Varey" <nigelv@clear.net.nz>]

telstra pay aud cheques or to an oz bank acc,which must be the same name as
shareholder.

it is a pity telstra can't send us nzd cheques,as do national mutual

regards nigel

ps there is a big difference between warrants & instalment receipts,warrants
are much more risky ,see below



UPMARKET


Warrants - Thrills and spills


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By Ben Scott


Trading warrants have given investors a rocky ride. Monthly turnover
rocketed from $34 million in August 1991 to $486 million in February this
year, but slid to $162 million in August. Because warrants cost just a
fraction of the shares on which they are based they magnify gains - and
multiply losses.

Some investors have seen their warrants soar; others have watched theirs
freefall. Wild swings in some warrants have led investors to bail out. Two
warrants in particular over poor performing shares - Cable & Wireless Optus
and the AMP - burned many investors. As much as a third of the market's
total capital was lost.

Why have investors lost money on trading warrants? Two reasons stand out:
inexperience and ignorance. Trading warrants are high risk investments, more
complex than ordinary shares. They suit experienced investors who are able
to trade them daily. Some investors should never use them. Others, and their
brokers, did not take enough time to fully understand them.

Shares has asked me to explain the composition of the Australian warrant
market and to give advice on trading warrants. Having lectured on warrants
for the Securities Institute of Australia and worked in the warrants
industry since its inception, I have many views on the best way to trade
warrants. However, I would encourage investors considering using warrants to
talk to their broker and read the newly released guide from the Australian
Stock Exchange - Understanding Trading and Investment Warrants - available
from the ASX or at www.asx.com.au.

The Australian warrant market

What is a warrant? They are "derivatives". While this has been a dirty word,
following several US derivative transactions that amassed large publicised
losses, Australian warrants are different in their structure.

A warrant is a long-dated - up to 10 years to maturity - option, issued by a
third party (ie not the ASX) and listed on the ASX. This means warrants are
a competitor to the ASX options market on the ASX's SEATS. The broad
definition of warrant (as contained in the ASX Business Rules) has allowed
investment banks and their financial engineers to structure warrant hybrids
that vary greatly given their distinct risks, rewards and investor benefits.
But all warrant hybrids contain some type of option as part of their
structure.

The ASX includes 10 warrant hybrids in its investor guide. While they vary
considerably, most investors would find appeal in some or all of them. For
simplification they are best divided into two groups: trading warrants and
investment warrants.

Trading warrants

Of the 459 warrants listed on the ASX, 50 per cent are trading warrants.
These are similar to exchange traded options, in that they are "decaying"
assets. An option gives the holder the right, but not obligation, to buy
(call) or sell (put) an underlying asset. However, while the holder of a
trading warrant has these rights, nearly all investors of trading warrants
buy them for gearing or leverage. This is because trading warrants cost only
a fraction of the underlying asset. At present trading warrants are offered
over equities, domestic and foreign indices and currencies.

All trading warrants use the terms set out in the table at right. Investors
should note the terms relating to warrants intended for purchase. These are,
if you like, the terms of your contract with the issuer. All trading
warrants will have these terms; issuers will use them to calculate the value
of a warrant.

The various types of trading warrant all have terms similar to those
outlined in the table but will vary from issue to issue and can be offered
over different underlying assets.

Equity warrants. The first type of warrant listed on the ASX, they are put
or call warrants over ASX listed shares. Requiring physical delivery, they
bear resemblance to the ASX options market.

Index warrants. Allow investors to trade their view on an index. Either put
or call, there are index warrants listed over the All Ordinaries, S&P 500
and Nikkei indices. Index warrants are cash-settled.

Currency warrants. Investors can trade their view on the value of the
Australian dollar as against the US dollar. Other cross-rates (eg US dollar
as against the Japanese yen) may also be introduced. Currency warrants are
denominated in Australian dollars and are cash-settled.

Barrier warrants. An extension of ordinary index warrants. In addition to
the terms of index warrants, they have an additional term called a barrier.
This is considered to be an extra exercise price, which limits the trading
range of the underlying asset.

For example, consider XYZWYC with a barrier at $9. This would mean that if
XYZ shares traded at or below $9 before expiry, the warrants would expire
worthless. Because there is a probability that this may occur, however small
that probability is, the price of XYZWYA with a barrier would be cheaper
than XYZWYA without. This in turn increases the leverage of the warrant,
something the sophisticated, aggressive investor wants.

Investment warrants

Investment warrants have been until recently a poor cousin to the trading
warrant market. But as the sophistication of warrants investors has grown,
so too has the diversity of hybrids offered. Investment warrants can be
traded for short term profits, such as the HOT or High Yield Instalments,
but most are designed for the longer term, conservative, wealth creating
investor. At present all investment warrants are offered over individual
shares or baskets of shares.

The ASX has classified the following hybrids of investment warrants:

Instalments warrants. Can be considered either a form of listed margin
lending or similar to the highly successful CBA and Telstra instalment
receipts. Essentially the investor borrows a portion of the underlying share
price on a non-recourse basis. Up to two years until maturity, holders
receive all dividends and associated franking credits. The usual tax
benefits associated with borrowing to invest apply and superannuation funds
are permitted to buy them.

Investors may also elect to transfer existing shares into instalments and
receive a cash-back amount without crystallising a capital gain.

Portfolio instalment warrants. Simply an instalment over a basket of shares.

Endowment warrants. In essence a 10-year hire purchase facility for buying
shares. Investors pay between 30 and 50 per cent of the underlying share
price, borrow the balance then use the dividends to pay the borrowed amount,
together with any funding costs. Unfortunately, franking credits are wasted.

Capital plus warrants. The investor invests a sum that is linked to the
performance of, say, a basket of shares. At maturity investors receive a
percentage of the upside of owning these shares (say, 115 per cent) and
their original investment. This is because the investment is guaranteed
should the price of the basket of shares fall.

Low exercise price warrants. Similar to the ASX-listed low exercise price
options (LEPOs). They are essentially a deep-in-the-money call warrant with
a low exercise price (usually one cent) relative to the underlying share
price. They offer a cheaper form of funding than margin lending and have
particular appeal to offshore investors. Although they do not pay dividends
or franking credits, dividends are priced into the product so that the
investor is compensated.

They have been used for large tax-driven corporate - plays such as the
selldown of Westpac shares by Lend Lease in 1996.


Golden rules for trading warrants


Trading warrants until recently were the most popular warrant hybrid bought
by investors. They dominated ASX turnover volumes. Indeed, 50 per cent of
all warrants listed are trading warrants.

Regarded by many as being the most misused type of warrant, they are called
trading warrants as most are marketed just as that - providing the ability
to capture short term profits by picking fluctuations in the underlying
asset.

Before handing over their cash investors are required to read and understand
the ASX publication Understanding Trading and Investment Warrants. The
booklet contains a form that investors sign, stating they have read the
booklet and understand the risks associated with warrants.

>From there, with a little education from your stockbroker or financial
adviser and a set of golden rules, investors should be able to successfully
mitigate losses and maximise profits by trading warrants.

The underlying asset

Investors need to form a view on the asset that underlies the warrant. Like
any derivative product, one of the most important elements is to have a view
on the direction of the "underlying" (as it is known): that knowledge is as
important as understanding the warrant itself. Just as one would research a
share thoroughly before buying, so too should you study the asset behind
your warrant.

Unlike shares, warrants are decaying assets. Investors are encouraged not to
buy them just because they are cheap. Losses will quickly ensue.

Is the view positive or negative?

Investors will look to buy a call warrant if the view is positive or a put
warrant if it is negative. Put warrants allow investors to profit on a
negative view.

What is the time frame of your view?

Investors must then decide the time period in which their anticipated view
will be realised. This will enable you to buy a warrant with the appropriate
amount of time to expiry.

For example, if the view is that XYZ shares will rise in value between now
and December, you should not be looking at warrants that expire in October.
It is also relevant to the exercise price: can the share price reach the
exercise price adequately before expiry?

Because warrants are decaying assets, the longer one holds them the more
"time value" will be paid. Time value is similar to the value paid under an
insurance policy. Suppose you were to insure your health for 12 months and
the cost was $1000: then you decide you wish to insure your health for only
one month for a cost of $100. So between 12 months and one month that
insurance policy will erode in value from $1000 to $100. This is because the
probability of being injured and the insured period decreases over time.

It follows that the time value paid for a warrant is the opportunity cost
for holding that warrant. The greater the time, the greater the probability
that the share price will move. This in turn means that longer dated
warrants will be more expensive than shorter dated, as there is a greater
opportunity/probability for the shares to perform.

Further, the value of a warrant comprises two components - intrinsic value
and time value. (Some investors may be familiar with the components used to
value a warrant. While this is useful, most investors will rely on the
market and the issuers to determine the fair value of the warrant.) The
intrinsic value is equal to the difference between the exercise price and
the share price - that is, the amount that the warrant is considered to be
"in the money".

The remaining value of the warrant is its time value.

Consider the following. XYZ shares are trading at $11 and XYZWYA is a call
warrant with an exercise price of $10. If XYZWYA warrants are trading at $2,
then the relevant values are:

Intrinsic value = share price - exercise price = $11 - $10 = $1.

Time value = warrant value - intrinsic value = $2 - $1 = $1.

Warrants value = time value + intrinsic value = $1 + $1 = $2.

As a rule of thumb, a warrant will usually lose one-third of its time value
during the first two-thirds of its life. Further, no matter what the time to
maturity, this rule will still hold; that is, the

time value will fall by one-third over the two-thirds of the time to expiry.

Investors should regard time to maturity as an important step in assessing
which warrant to buy. The rate of time decay (as the process is known)
increases as maturity looms. It is not, as The Rolling Stones sang, a case
of "Time is on our side" but rather "theta, theta, the profit eater" (theta
is the measurement of time decay of a warrant).

How much gearing/leverage do you want?

Just as investors form a time frame for their view, they should have an
appreciation of how much gearing they want. Gearing can be considered as the
gear in which you wish to drive your car. The more aggressive and
experienced driver will consider using higher gears resulting in higher
speed. Conversely the more conservative investors will choose a lower gear
allowing for a safer journey.

Choose the right warrant, not the right volume

Many investors of trading warrants will buy the warrant that has the highest
volume. This is a no-no - high liquidity does not equal high returns. Look
outside the square and decide for yourself which warrant best suits your
risk profile, and buy that warrant. If there are two similar warrants,
investors may choose the warrant with higher liquidity for easier dealing.

Monitor the performance of you warrants

All investors should monitor daily the performance of trading warrants. The
internet has presented an excellent forum in which investors can do this.
Remember warrants are decaying assets and as time goes by, so does a little
of the value of your warrant.

Investors should also understand the delta of each warrant. The delta is a
mathematical calculation that approximates the probability that the warrant
will be exercised. Investors can use it to calculate expected warrant price
movements relevant to the movement of the underlying share price.

For example, if we know that the delta of a warrant is 50 per cent and the
underlying share price rose $1, then a call warrant's price will increase
about 50 cents ($1 x 0.50).

Repeat this research for each purchase

The characteristics are constantly changing as they react to the movement in
the underlying asset price and the time to maturity. Therefore buyer
beware - do not automatically buy the same warrant you bought last time just
because you returned a profit.

Other tips

Many investors use margin lending to increase their exposure to shares and a
way of accessing some of the capital gain from rising share prices. Margin
lending is a form of borrowing and, like any borrowing, there is a cost
attached to borrowing the funds.

What many investors may not know is that call warrants issued over equities
can in certain circumstances offer a cheaper alternative to margin lending.
Warrants are priced using several variables, one of which is a funding cost.
This is because when a trading warrant is sold, shares are usually bought to
hedge that position. In essence the price of a warrant is valued using the
assumption that the buyer (investor) is borrowing the exercise price.

When the share price rises significantly above the exercise price, call
warrants are said to be deep in the money. If we use the XYZWYA example
above but assume the share price is $20, the purchasing of the call warrant
is effectively borrowing $10 (the exercise price).

Why is this a cheaper form of margin lending? Because the interest rate used
to calculate the cost of funding is the wholesale interest rate,
substantially cheaper than margin lending rates.

THE XYZ OF WARRANTS

 Put or call warrant Description
Underlying asset "XYZ shares" The underlying security either of an equity,
index or currency.
ASX code XYZWYC ASX SEATS reference code.
Issuer Young Bank The counterparty of your warrant purchase.
The ASX does not guarantee warrants like options.
Exercise price (aka strike) $10.00 Agreed price at which the underlying
security can be bought (call) or sold (put), in this case XYZ shares.
Exercise style American Governs when holders can take up their rights to
exercise the warrant. Can be either American - exercise at any time up to
maturity - or European - exercise only at maturity.
Expiry (aka maturity) 31/12/99 Warrants have a finite life and mature at
expiry.
Conversion ratio 2:1 The number of warrants required to exercise one of the
underlying assets.
Settlement Physical delivery Settlement can be either physical (there must
be delivery of shares) or cash settled (the intrinsic value is paid as
settlement).



Explore:


Contents for this issue:
  Vol. 4 No. 10, October 1999







>From Australia's Shares magazine October,1999.
© 1999 BRW Media Your use of this site is governed by our Legal Notice

-----Original Message-----
From: Philip Robinson <fire_appliance@hotmail.com>
To: sharechat@sharechat.co.nz <sharechat@sharechat.co.nz>
Date: Friday, 29 October 1999 10:25
Subject: [sharechat] Brent/TELCA/Ozzy shares on NZSE: Telstra


>Brent: I also wanted to join the chorus, saying the Brent this system
>wouldn't be possible without persons such as yourself, willing to share
what
>you know with others trying to learn the system.
>
>Telca: I was looking at the discussion on TELCA and thinking thats a pretty
>good deal, just there must be a catch. But there does not seem to be. My
>question is what is the benefit for Warrenburg to issue these receipts, and
>distribute full dividends off the shares that they own to people who have
>only half paid for them. Is it that I am not seeing something obvious?
>
>Ozzy shares on the NZSE: Telstra.
>My question with these is that when you buy Telsta on the NZSE is it
handled
>by a NZ share registry or does one need to sort out an Ozzy share registry
>and also how are dividends paid, to a NZ bank a/c? or does one need to set
>up an Australian bank account also.
>
>Many thanks, Philip Robinson.
>
>______________________________________________________
>Get Your Private, Free Email at http://www.hotmail.com
>
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