The Bull

Wednesday 20

June, 2018 1:31 PM



Warrants question

What happens when a warrant is out-of-the-money, or in-the-money?

What happens when a warrant is out-of-the-money, or in-the-money? Matt Comyn, CommSec

What happens when a warrant is out-of-the-money, or in-the-money?  Can you give me an example of both please.

Response

Warrants are financial instruments that derive their value from another underlying instrument and are issued by banks, governments and other institutions.  They are commonly and broadly split into two categories; investment style warrants, which are longer term and carry a reduced degree of risk, and trading style warrants, which are typically shorter term and are associated with higher levels of risk and return.

Similar to options there are two main types of warrants; Call warrants and put warrants.  Call warrants give the holder the right to buy the underlying asset at maturity, while put warrants give the holder the right to sell the underlying asset at maturity.  As with options, each warrant can also be regarded as being “in”, “at” or “out” of the money, which is a reflection of their intrinsic value.

The intrinsic value is the difference between the exercise price and the current price of the underlying share, and is a key component in determining the market value of a warrant.  A warrant’s intrinsic value is always greater than or equal to zero.

A call warrant is in-the-money when the exercise price is lower than the price of the underlying share.  For example, an investor holds a BHP call warrant with an exercise price of $35.00, meaning, at maturity the investor can purchase BHP shares for $35.00.  If BHP shares were currently trading at $38.00, the investor holds an “in-the-money” warrant, with an intrinsic value of $3.00 per warrant.

Conversely, a call warrant is out-of-the-money when the exercise price is higher than the price of the underlying share.  Using the same example, if BHP shares were trading at $30.00 the investor’s BHP call warrant with an exercise price of $35.00 would be termed “out-of-the-money” and would have an intrinsic value of $0.

The same logic can be applied to put warrants.  A put warrant is in-the-money when the underlying share price is below the exercise price.  As an example, an investor holds a WOW warrant with an exercise price of $30.00, which gives them the right to sell WOW shares for $30.00 at maturity.  If WOW shares are currently trading at $27.00, the investor’s warrant is “in-the-money”, and has an intrinsic value of $3.00 per warrant.

On the other hand, a put warrant is out-of-the-money when the underlying share price is above the exercise price.  Using the same example, if WOW shares were trading at $32.00 the investor’s WOW put warrant with an exercise price of $30.00 would be termed “out of the money” and would have intrinsic value of $0.

Finally, both call and put warrants are termed “at the money” when the exercise price is equal to the price of the underlying.  Like “out of the money” warrants, at-the-money warrants have an intrinsic value of $0.

For more information

For further information on Warrants, visit the Australian Stock Exchange website www.asx.com.au.  The ASX have a booklet titled “Understanding Trading and Investment Warrants” which is designed to give you a comprehensive understanding of the different types of warrants and how they work.  A number of strategies are also available for download.

By Matt Comyn, General Manager, CommSec  

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Important Information

Commonwealth Securities Limited ("CommSec") ABN 60 067 254 399 AFSL 238814 is a wholly owned, but non-guaranteed, subsidiary of the Commonwealth Bank of Australia ("the Bank") ABN 48 123 123 124 AFSL 234945.

This article was produced by CommSec. The information in this article is general in nature and does not take into account any investor's particular objectives, financial situation or needs. In considering its appropriateness, investors should read the relevant product disclosure statement and consult a financial adviser before making an investment decision. Except to the extent that any liability under any law cannot be excluded, no liability for any loss or damage which may be suffered by any person, directly or indirectly, through relying upon any information or statement in this document is accepted by the Commonwealth Bank or CommSec or any of their directors, employees or agents, whether that loss or damage is caused by any fault or negligence on their part or otherwise. Commonwealth Bank and its subsidiaries do not guarantee the obligations or performance of CommSec or the products or services offered.

Information contained in the brochure entitled “Understanding Trading and Investment Warrants” is produced by ASX Operations Pty Limited ABN 42 004 523 782 (‘ASX’) and intended for general information only. Neither ASX nor any related body corporate of ASX has had any involvement in the preparation of any part of this document, accepts responsibility for any statement herein, or has been involved in or consented to the issue of this document.

 


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