More pile in for a gamble on warrants

Simon Watkins|Mail13 April 2012

TRADING in covered warrants, investment products that allow people to gamble on shares without buying them, has soared to record levels. The surge comes as traditional share buying has slumped into its usual summer torpor.

The volume of covered warrants traded in July jumped to more than 3,000 with a value of about £11 million - more than five times the value traded in November last year when the products were introduced in Britain.

The latest rally in the stock market should boost trading even further, according to Mark Valentine, executive director at Goldman Sachs, the UK's biggest issuer of covered warrants.

At comdirect, the online trading arm of Commerzbank, chief executive John Glendinning, described warrants as 'one of our fastest growing products in the United Kingdom'.

Covered warrants are already popular on the Continent, in particular Italy and Germany, where they have been available for many years.

They became available in the UK only last year when the Financial Services Authority relaxed its rules, allowing them to be sold to ordinary investors.

The appeal of covered warrants for some investors is that gains are greater than with shares.

When investors buy covered warrants, they assume the right to buy or sell a share at a set price in the future. A warrant for the right to buy is called a call warrant. The right to sell is a put warrant.

For example, if you believe that shares in company ABC, currently at £1, will rise by the end of the year, you might buy £1 call warrants with a final exercise date in December.

Imagine the warrant costs 25p and the share price in ABC doubles to £2. The warrants allow you to buy the shares for just £1 each.

This means that each warrant is instantly worth £1. Since the warrants cost just 25p the profit is for the investor is 75p on each warrant.

In other words, ABC shares doubled in value, but the warrant investor has tripled the stake.

But there is the risk that losses are also multiplied.

If the shares in ABC fell by just a penny to 99p, the call warrant giving the right to buy becomes £1 is worthless. The investor loses all of the 25p paid to buy the warrant while ordinary investors who had paid £1 for the share would only be down only 1p.

The effect of multiplying gains or losses is similar to taking a spread bet or trading in the futures and options market. But with covered warrants, losses can never be more than the amount invested.

Another appeal of warrants is that they can be used to gamble on share price falls by buying a put warrant based on a future selling price.

This feature may have added to the attraction of warrants in recent volatile stock markets.

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