Benefits
Leverage
A warrant is usually priced at a fraction of the underlying share price. This allows you to trade more warrants than the underlying shares for the same investment outlay.
Trading warrants therefore, offer benefits of leverage or gearing in varying degrees. For instance, a small percentage gain in the underlying share price may lead to a larger percentage gain in the value of a call warrant
Diverse market access
Unlike warrants on individual stocks, index and basket warrants give you exposure to a sector or market, as their value are linked to the performance of a benchmark index and pre-defined basket of shares respectively.
This eliminates the need of trading in a market portfolio of individual stocks.
Unlimited upside but limited downside
The maximum potential loss to you is limited to the warrant price, which is usually a fraction of the share price. The potential gain of a warrant may be unlimited as it depends on the movements of the underlying share.
Protects the value of your asset
A "put warrant" allows you to hedge against a fall in the price of a stock in your portfolio. You are, therefore, assured of a minimum value equivalent to the exercise price for the stock in your portfolio.
Releasing capital for other investments
Call warrants may be used to free up capital invested in shares.
By selling existing share holdings and purchasing a corresponding number of call warrants for a fraction of the price, you can maintain exposure to the underlying share price increase while releasing capital from holding the shares.
Risks
Limited life of warrants
Warrants have an expiry date, so it is essential that you select a warrant that has sufficient time to expiry to match your market expectations.
Leverage
Leverage is a "double-edged" sword. In addition to magnifying gains, warrants can also magnify losses when the value of the underlying asset moves against the warrant position.
For instance, a fall in the price of the underlying share can lead to a larger percentage loss in the value of the call warrant.
Credit risk
There is a risk that the warrant issuer will not be able to fulfill its obligations during the exercise of the warrants.
Therefore, you should assess the credit risk associated with the warrant issuer.
Currency risk
In the event that a warrant is denominated in a currency other than Singapore dollars, you will be subject to exchange rate fluctuations that may have an adverse effect on the value, price or return of the warrant.
Market risk
Similar to other investments in the securities market, the market value of a warrant is susceptible to events that affect its demand and supply.
Hence, the market value of your investment will fluctuate accordingly.
Liquidity risk
Liquidity risk occurs when a warrant holder is unable to sell his warrants for a reasonable price in the market.
This is due to insufficient buy orders, which affects the market price of the warrants.
Default on market-making obligation
A warrant issuer who has committed to make a market in the warrants it issued may not fulfill its obligation due to unforeseen circumstances that may arise.
Hence, you may experience liquidity risk despite a commitment from the warrant issuer to make a market.
Extraordinary circumstances
The warrant issuer may declare a lapse of the warrant or bring forward the expiry date.
This occurs when a circumstance listed in the terms and conditions of the warrants issue arises, such as the delisting of the underlying asset.
Selected information was taken from http://www.sgx.com/
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