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Covered Warrants

Covered Warrants by Alpesh Patel

What are they?

What are they?

What if I told you there is a financial product hugely popular with private investors in Germany and Italy, suited to falling as well as rising markets? It's tradable through your normal online broker, often cheaper than buying stocks.

Interested? You should be.

Why oh why?
So why do we need yet another financial product when the markets are more choppy than a single-handed transatlantic yacht crossing?

Not only are these products hugely popular on the continent, but UK private investors through the growth of spread betting and CFDs have become familiar with trading with margined products (where you earn potentially greater returns for every pound invested than you would on just owning the share itself). Such volatile and falling markets mean the demand for choice on how to profit in that environment increases.

So what are they?
First the boring definition: a warrant gives an investor the right but not the obligation to buy (a 'call' warrant) a specified underlying asset (eg Vodafone shares ) at a particular price ('the strike price') within a specified time frame (the maturity). Don't worry it's not as complicated as it sounds.

The Vodafone £1.50 Dec-04 Call Warrant gives the investor the right to buy Vodafone shares at £1.50 up to December 2004. Of course such a right could be very valuable, or it could be worthless depending on many factors such as the future uncertainty of Vodafone's share price, how much money you could be earning elsewhere etc.

The price you pay for this right is the 'premium'. The most you can lose is the premium. The most you can make is technically unlimited, so there is some downside protection automatically built in.

But usually if you 'exercise' your rights and call for the underlying shares you are given the cash profit (difference between the then share price of Vodafone and £1.50) instead of the share itself - thereby avoiding stamp duty.

Essentially we are talking about trading the premium. That is trading the price of the warrant. We want to buy low and sell high. So we must know what makes the price of the warrant? Well the most important component is the price of the underlying security on which the warrant is based.

So essentially we are buying and selling the price of the underlying asset. Well, we're used to that. That's how we look at Vodafone and other securities now - in terms of where their prices might be going. So there is nothing too hard there.

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