Cai Jin

Trading option that warrants crowing about

Swiss lender UBS has stepped up its activities in the warrant market. Mr Johnny Yu, its head of public distribution - Asia, notes that it is already one of the top warrant issuers in Hong Kong, especially on Hang Seng products, and will be able to le
Swiss lender UBS has stepped up its activities in the warrant market. Mr Johnny Yu, its head of public distribution - Asia, notes that it is already one of the top warrant issuers in Hong Kong, especially on Hang Seng products, and will be able to leverage this advantage to provide liquidity for the warrants it issues in Singapore.PHOTO: BLOOMBERG
MR. BARNABY MATTHEWS
MR. BARNABY MATTHEWS

Revival of warrant market draws new players and offers opportunities to retail investors

Spring is in the air as the Year of the Golden Rooster struts in, with the structured warrant market looking forward to a further thaw in sentiment after a spectacular rally following years in the doldrums.

Overall warrant turnover more than doubled last year to $7.71 billion from $3.82 billion in 2015 to hit its highest levels in five years.

This rebound took place against the backdrop of a lacklustre stock market whose total turnover during the year fell 2.89 per cent to $271.91 billion.

And the remarkable revival looks set to keep going. Almost $1 billion worth of warrants have changed hands so far this month. This makes January busier than most months last year, with the exception of December when warrant turnover shot up to $1.19 billion.

Warrants are essentially options that give an investor exposure to blue chips or stock market indexes at a fraction of the cost of investing in these shares. What makes them especially attractive to retail investors is that their prices move closely in tandem with the share or index which they track.

But this can also make warrants very risky. A small change in the price of the stock or index can spawn a big percentage swing in the warrants created to track it - and this can leave investors facing huge losses.

KNOCK-ON EFFECT

When these issuers enter the market, the increased competition encourages all issuers to increase their bid and offer volumes on their warrants. By doing so, the issuer is able to provide more liquidity in a particular warrant and hopefully attract more investors to buy it.

MR BARNABY MATTHEWS, head of derivatives for SEA at Macquarie Securities.

Although structured warrants have been on the scene for more than two decades, it was only in the past 15 years that they gained popularity among investors here.

This was in the wake of efforts by issuers to become "market makers" for warrants. This involved offering competitive "bid" and "offer" quotes throughout the day to allow traders to get in and out of the warrants.

Between 2004 and 2007, when the popularity of warrant trading reached its height just before the onset of the global financial crisis, total warrant turnover jumped by a hefty 16.6-fold to $28.2 billion.

It's been downhill since, despite a brief revival in 2011, as one crisis after another spooked retail investors and kept them out of not just warrants but the rest of the market as well.

One question on my mind as I traced the revival in warrant trades is whether this is just another one-off affair, much like in 2011.

Not necessarily, said Mr Barnaby Matthews, head of derivatives for SEA at Macquarie Securities.

One significant change has been the emergence of new players in the warrant market. Swiss issuer Vontobel entered in late 2014 while Swiss lender UBS has stepped up its activities significantly. Also joining in the fray was US lender JP Morgan.

What prompted them? In the case of UBS, Mr Johnny Yu, its head of public distribution - Asia, noted that the lender is already one of the top warrant issuers in Hong Kong, especially on Hang Seng products. It is able to leverage this advantage to provide good liquidity for the warrants it issues in Singapore.

The entry of these players offers warrant traders more choices on where to place their bets as they were previously restricted mostly to warrants issued by Macquarie.

Macquarie's Mr Matthews said: "When these issuers enter the market, the increased competition encourages all issuers to increase their bid and offer volumes on their warrants. By doing so, the issuer is able to provide more liquidity in a particular warrant and hopefully to attract more investors to buy it."

This has led to a virtuous circle, as the increased bid and offer volumes attract the big-time traders to step up their trading activities. The significant rise in warrant trading is also beginning to draw fresh investors.

Mr Matthews noted Singapore Exchange (SGX) data showing a rise of 100 unique CDP accounts trading warrants in December.

"Clearly, the increased activity and volatility have attracted smaller retail investors," he said.

What occurred in the warrant market with new players stirring up activities in a big way has been repeated since last November in the broader market where increased purchases of bank stocks and other blue chips by fund managers are luring other investors back into the market.

But Mr Matthews said that in order to revive the warrant market further, retail participation will have to increase significantly. "The increased trading volume is good but it is primarily attracting a small number of large traders."

There are issues peculiar to the warrant market that are tripping up retail investors. For example, any new investor wanting to trade warrants has to sit an online test if they have not traded the product before, or do not possess the relevant educational qualification or working experience to show they are financially sophisticated enough to understand the product.

This follows guidelines put in place in 2012 after the huge losses retail investors sustained in instruments such as Lehman minibonds during the global financial crisis.

But besides knowledge about warrants in the online test, a person is also examined on other financial products such as futures, options and exchange-traded notes.

Hence, one immediate question is whether the test can be reduced to merely assessing a person's understanding of warrants if he is not interested in trading the other products.

One attraction about warrants is that most of them are traded well below $1, making them affordable to retail investors. But this attractiveness can also trip up an investor because shares and warrants are traded at a minimum lot size of 100 units.

As Mr Sia Cheong Yew, a former business editor with this newspaper, noted in a recent letter, he put up 9,000 warrants for sale but only 100 units were transacted at the end of the day. Because of this partially filled trade, he ended up having to pay the broking firm $17.95 due to the proceeds being insufficient to cover brokerage and other charges.

Sure, the SGX has argued that its trading engine does accept "fill or kill" orders which allow an entire order to be cancelled if it is only partially filled, but this feature does not appear to be available on many online trading websites that investors use.

Mr Sia's unfortunate experience also begs the question as to whether it is better to revert to a board lot size of 1,000 units for trading of warrants and low-priced stocks.

Hopefully, some of these issues will be resolved eventually. In the meantime, it is worth noting that the warrant market in Singapore took off spectacularly in the previous Rooster Year of 2005, with turnover surging by an eye-popping 6.2-fold to $10.64 billion that year.

Now that another Year of the Rooster is upon us, hopes run high that there will again be plenty to crow about in the warrant market.

A version of this article appeared in the print edition of The Straits Times on January 30, 2017, with the headline 'Trading option that warrants crowing about'. Print Edition | Subscribe