What are Warrants?

What are Warrants?

Warrants are derivative securities that give investors the right (but not the obligation) to buy or sell an underlying asset at a predetermined price within a specified period.

Warrants can be traded on the securities market of the Hong Kong Exchanges and Clearing Limited (HKEX) before expiry. At maturity, they are generally settled in cash without physical delivery of the underlying assets.

Warrants can be linked to a wide range of assets, including individual stocks, stock indices, currencies, commodities, or a basket of securities. They are issued by independent third parties, usually investment banks, which have no affiliation with the issuers of the underlying assets.

Warrants traded in Hong Kong typically have a maturity period ranging from 6 months to 2 years, and each listed warrant has a fixed expiry date.

Classification of Warrants

① By Holder’s Rights

Based on the rights granted to holders, warrants are divided into Call Warrants and Put Warrants:

• Call Warrants

Give the holder the right (but not the obligation) to purchase a specified quantity of the underlying asset at the strike price within a fixed period. Investors who are bullish on the underlying asset will buy call warrants.

• Put Warrants

Give the holder the right (but not the obligation) to sell a specified quantity of the underlying asset at the strike price within a fixed period. Investors who are bearish on the underlying asset will buy put warrants.

② By Exercise Style

Warrants are classified into American Style and European Style:

• American Style Warrants

Holders may exercise their rights at any time from the listing date up to and including the expiry date.

• European Style Warrants

Holders may only exercise their rights on the expiry date.

In practice, European Style warrants dominate the Hong Kong market.

Naming Convention of Warrants

The short names of warrants shown in newspapers and financial platforms contain key product information.

Investors can identify the underlying asset, issuer, maturity, product type, and series code from the name etc.

Common Terms of Warrants

Entitlement Ratio

Refers to how many units of the underlying asset one warrant represents.

If the ratio is shown as “0.1”, it means 10 warrants correspond to 1 unit of the underlying asset. In calculations, the reciprocal (1 ÷ 0.1 = 10) is normally used.

Premium

A measure of how expensive a warrant is relative to the underlying asset:

• Call Warrant Premium = (Warrant Price × Entitlement Ratio + Strike Price − Underlying Price) ÷ Underlying Price × 100%
• Put Warrant Premium = (Warrant Price × Entitlement Ratio − Strike Price + Underlying Price) ÷ Underlying Price × 100%

Premium changes constantly as the prices of the underlying asset and warrant fluctuate. Generally, the lower the premium, the closer the warrant’s value tracks the underlying asset.

Gearing Ratio

Reflects the leverage effect of a warrant:

Gearing Ratio = Underlying Price ÷ (Warrant Price × Entitlement Ratio)

Implied Volatility (IV)

An important indicator for valuing warrants. Most European warrants are calculated using the Black-Scholes (B-S) model. Investors can obtain this data directly from market sources without manual calculation.

Higher implied volatility generally means a relatively higher warrant valuation and greater potential downward pressure; lower IV means the opposite. Implied volatility is a reference indicator, not the sole determinant of warrant prices.

Delta (Hedge Ratio)

Measures the sensitivity of a warrant’s price to changes in the underlying asset price. It also indicates how much of the underlying asset issuers need to buy or sell to hedge their risk. The value ranges between 0 and 1.

• Closer to 1: the warrant is deeper in-the-money
• Closer to 0: the warrant is deeper out-of-the-money
• Around 0.5: the warrant is near at-the-money