A covered warrant gives the holder the right (but with no obligation) to buy or sell an underlying asset, at a specified price, on or before a predetermined date. For many investors, covered warrants will seem similar to options. Covered warrants typically have longer maturities than options, and are issued over a wider range of assets.
The terms are also more varied – covered warrants are highly flexible and can be issued on underlyings meet market demand. For example, you can invest in covered warrants based on foreign equities and indices, the housing market or commodities such as gold, silver and oil.
With covered warrants you cannot lose more than your initial investment. Your maximum loss is known in advance, and there are no margin calls, ie further payments to maintain your position. This differentiates covered warrants from some other forms of derivatives.
Stop-loss Warrants
Stop-loss warrants allow investors to take a bullish or bearish view on the underlying asset in a similar way to a futures or CFD investment. They replicate the performance of the underlying, but are leveraged investments with an inbuilt stop-loss mechanism.
Key Features
- Leverage – as with covered warrants, rather than paying for the underlying in full, investors pay only the difference in the underlying value and the strike price. The remaining capital required to purchase the underlying (in the case of a call) is borrowed from the Issuer, and the cost of this is built into the price of the warrant.
- Stop-Loss – feature an in-built stop-loss mechanism, ensuring the investor’s maximum potential loss is equal to initial capital invested. Should the stop-loss level be breached, the warrant will automatically exercise. Depending on the terms of the security, the warrant may automatically redeem at zero or alternatively it may retain some intrinsic value at the stop-loss level.
Because of the leverage inherent in covered warrants and stop-loss warrants, percentage movements in the price of the underlying are amplified. As such, investment in these instruments should be considered high risk.
Who would buy Covered Warrants or Stop-loss Warrants?
Stop-loss warrants amplify the performance, positive or negative, of the chosen underlying asset. As such, they are designed for those who have a bullish (calls) or bearish (puts) outlook on the underlying and want small movements in the underlying to lead to large profits/losses.
Further details are available in the brochures on the Educational Resources page.