Understanding Derivative Warrants

1. What Are Warrants?

Derivative Warrants are instruments that give investors the right to "buy" or "sell" an underlying asset at a pre-set price prior to a specified expiry date. They may be bought and sold prior to their expiry in the market provided by HKEx. At the expiry settlement is made in cash rather than a purchase or sale of the underlying asset. Derivative warrants can be issued over a range of assets, including stocks, stock indices, currencies, commodities or a basket of securities. They are issued by a third party, usually an investment bank, independent of the issuer of the underlying assets. Derivative warrants traded in Hong Kong normally have an initial life of six months to two years and when trading in the market each derivative warrant is likely to have an unique expiry date.

2. Types of Derivative Warrants

Derivative warrants are generally dividend into two types: calls and puts. Holders of call warrants have the right, but not obligation, to purchase from the warrant issuer a given amount of the underlying asset at a predetermined price (also known as the exercise price) within a certain time period. Conversely, holders of put warrants have the right but not obligation, to sell to the warrant issuer a give amount of the underlying asset at a predetermined price within a certain time period. Derivative warrants are exercised when holders use their rights to purchase or sell the underlying assets. In Hong Kong derivative warrants are usually settled in cash when they are exercised at expiry. In fact most derivative warrants are sold by their holders prior to their expiry dates.