Wednesday, January 30, 2008
Volatility & Warrant
Question: In view of the high volatile market, do you think one should continue to invest in warrant as doing warrant will increase one's exposure to higher volatility in the already highly volatile market. I had a discussion with on friend on that but i disagree with him on the current situation that we should be buying the underlying instead of adding more volatility by leveraging on warrant. My view is that we cannot lower the volatility through warrant but we can control the risk exposure by lowering the trade value of warrant and yet achieve a comparable risk/gain/loss. Am i right to say that? An example would be a $20 share and a 10c warrant with June/July expiry, out of money warrant. Conversion is 10. A very vague guide but what i want to say is by varying the trade size, we can achieve good exposure with comparable risk.
Comment - Warrants trading in a down trend marked with intense volatility is not for the faint hearted, but to me, a genuine warrant player absolutely loves this market. Intense volatility and grave mis-pricing, the best kind of markets to trade warrants. If you are cashed out, maybe you can risk 10%-20% of capital to do this. Its pretty simple.
Follow some basic rules:
a) Do not buy on up days, buy on down days where mis-pricing is more readily available. You also have a buffer buying on down days.
b) Throw out all warrants with less than 30 days to expiry.
c) Only consider those with Effective Gearing of more than 5x and a Premium of Less than 20%.
d) Preference to those with lower absolute prices, i.e. a 10 sen warrant is better than a 30 sen warrant.
e) Sell on up days. For the assumed risk, you should be expecting 30%-50% return per trade.
f) Because you selected those with high gearing and low premium, even on further down days, the warrant price would not fall by a big percentage. Set a cut loss level.
Like I said, this is not for everyone.