Warrants

We stumbled upon this advertisement in Singapore from a financial instituition and thought what great marketing material it was.

What they wrote seem to imply that their hedging strategies are perfect ( second paragraph) and any gain to the warrant holders are taken from the losses of the warrant issuers' counterparty whom they entered into positions with to hedge their warrant positions. Its not really right to state its a win-win situation between issuers and warrant holders since the issuers are still earning the premiums with no risk ( assuming perfect hedge) but risks still exists for the warrant holders who could still lose the premiums. Maybe this situation exists to " compensate" the warrant issuers for all the hardwork they have done to package such a derivative product.

And the truth of the matter is, in our opinion, its indeed a zero sum game since there is no such thing as a perfect hedge. When warrant holders win, warrant issuers still lose, although, the lost is just minimised. Refer to the following link where it is written :

"According to Financial Supervisory Service data, domestic brokerage houses posted a combined 55.4 billion won loss from equity-linked warrant trading between April and August last year, while foreign houses logged a 1 billion won loss. These warrant issuers failed to hedge adequately against markets moving against them as the benchmark KOSPI jumped 29 percent. "

Anyway, we stumbled upon this somewhere in the internet:

"For the covered warrant, the main concern of the issuer is how to attract the market investors to buy the issued covered warrant when the product is launched. In this consideration, the usual technique for the investment banker is to buy lot of the corresponding share at a low price and suddenly push up the stock price. It then issues the covered warrant at a strike price based on the high stock price. Often they will also support the stock price for a while, but when their warrant have been nearly sold to the market, the stock price will drop. As the strike price of covered warrant is normally quite high, the premium and leverage ratio are also quite high. The high leverage ratio is ideal for investment consideration, but the high premium is very risky, and the covered warrant can easily become "Wall-paper warrant" in bad market situation. Investors should always remember that the issuer of the covered warrant is an investment banker who is VERY EXPERIENCED in market manipulation. When a covered warrant is approaching its expiration date, the issuer will try to beat down the price of the stock, such that the issuer can buy back enough stock from the market to be later distributed to the warrant holders who are willing to exercise the warrant. In the extreme, the issuer may even try to drag down the stock price to make it lower than the strike price. The warrant thus becomes 'Wall-paper' and no warrant holder is willing to exercise it. The warrant issuer thus makes a neat big profit. This normally occurs to the weaker blue chips (there is only covered warrants for blue chip stocks in HK) like Cathay Pacific and Dairy Farm. There are some issuers who are very NOTORIOUS in killing their covered warrant investors! "

Directors' Trades
Insider pares stake in Cosco
Oct 5, 2006
The Straits Times
INSIDERS have almost stopped selling shares in Cosco Corp.


The only exception is Mr Zhou Xie Dong, director of its China unit, Cosco Shipyard Group (CSG).

Records kept by Shareinvestor.com show he sold 100,000 Cosco shares at $1.65 apiece on Sept 20 and another 43,000 shares at $1.66 each on Sept 29.

Following the two sales, his stake has now been pared to 257,000 shares.

Besides Mr Zhou, other parties who sold Cosco shares recently included Madam Mina Chan - the wife of independent director and former MP Wang Kai Yuen - and Mr Wang Zai Zhong, another CSG director.

But dealers have noted that their sales were easily absorbed in the market, as about nine million Cosco shares are traded daily, on average.

One dealer said that interest in Cosco has stayed red-hot because of the fresh issues of covered warrants on the stock.

'New warrant issuers are coming into the market and they are all chasing after the same few hot stocks like Cosco,' said a dealer.

And Cosco's share price may have been chased up by warrant issuers buying the mother shares to 'cover' the risks associated with issuing covered warrants on the stock, he added.

Yesterday, Cosco climbed four cents to a new high of $1.73 on a volume of 17.9 million shares.

The most actively traded Cosco covered warrant was one issued by Merrill Lynch

It ended 2.5 cents up at 26 cents on a hefty volume of 15.7 million units.