Friday, March 30, 2007

Warrants Premium

Andrew Lim said...
Can you tell me why those warrants are still trading at a lower premium now although their mother share has almost recovered back to the pre-correction levels? It is so hard to set an entry and exit price since the premium can varies from time to time

I assume you are saying the premiums just before the March selldown are a lot higher than the premiums now for warrants. There was little risk since the beginning of the year leading up to the March selldown. In fact, Malaysia was the best performing market in the world ytd then. As warrants are necessarily a bull market leveraged instrument, the premium investors are willing to pay will be higher in a rising market.

Even though mother share prices may have climbed back to pre-selldown levels, the premium would have shrunk because the outlook is a lot different than the first couple of month of the year. Now, investors are "pricing in risk", new all time highs does not look an easy mountain to climb compared to a few weeks back. You can say the level of bullishness has be tamed somewhat.

Lower premiums could also signal a lower volatility period for shares. You would not pay a high premium for Petronas Dagangan warrants because it does not budge much no matter what the overall markets might be doing. However, investors will pay a high premium for very volatile stocks, only when they do move do warrants get full value. The lower premiums could actually signal that markets will be flat to range-bound for the near future.

Due to the popularity of covered warrants, their premiums would have taken a dive following the selldown because covereds have a much shorter time to expiry, and a scare like the recent selldown may zap the risk appetite of investors. Time to expiry will take a quicker toll on premiums once a bull trend has been halted. Compared to the scene a few weeks ago, there are a lot more bears now before. So you have to adjust your entry and exit according to market sentiment, and not just mother share price.

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