Leverage your return by investing in warrant

Warrant may sounds familiar to retail investors, but not all of them understand how it work & even what is it.

Warrant is a right, which can be traded, of buying something at a predetermined price & has an maturation date.

Consider a case, Mr. A wanna buy a RM 500k house from Mr.B because he think the house worth more than that. But Mr.A has a cashflow problem, he can't get 500k. Then he ask Mr.B to issue a warrant stating that "The owner of this warrant has the right to buy the house at RM 500k anytime in the future but within 5 years." Which means the warrant will be expired after 2 years. And Mr.B sell this warrant to Mr.A with the price of RM50k. 50k for nothing tangible just a right. 4 years later, the house now worth RM 1 mil. Bringing the warrant, Mr. A meet Mr.B, Mr. A wanna use the right of the warrant. Mr. B has to do as stated in the warrant, which is selling the 1mil-house to Mr. B (the warrant holder) at the price of 500k. If Mr.A sell it out instantly, he gain 500K, minus the cost of the warrant, net profit is RM 450k. 50k turn out to be 450k, a not-bad 900% return. Change the point of view, how much the warrant worth if Mr.C wanna buy the warrant from Mr.A? The house worth 1mil, to buy the house need 500k, thus the warrant worth 500k. That amounts a 1,000% increase in value.

So how can we leverage our return through warrant? Let read another case.
Mr A & Mr B has 500k on hand. The same house and the same warrant like previous case exist here, and assume there are a lot of house to be sold. Mr A use the 500k to buy 1 unit of the house, he own the house instantly. Mr B buy 10 units of the warrant of the house and pay 500k just for the right and he own no house. 4 years later, 0.5M house become 1M house. Mr A sell it out & gain 0.5M or a 100% return. Each warrant of the house now worth 0.5M, Mr B sell all 10 warrants out and get back 5M or a 1,000% return.

So why not everyone trading only warrant instead of the real thing? What is the risk?

Considere this, 5 years later, the house price drop to 450k. (assume both of them haven't sold their houses/warrants) Mr A can decide wanna sold the house out or not with a loss of 50k or 10% decrease in value. But how much the warrant worth now? To convert the warrant to house need 500k. So who on earth wanna buy a 450k house by paying 500k instead of buying the house straightaway by 450k. That means the warrant now worth nothing, & will never worth anything cause it is going to expire one day later, even thought 1 week later, it's going to worth 1M again, the warrant will be just expired. In this case, Mr B loss everything or a 100% decrease in value.

How it work in share market?
It works the same way. Say YTL Power now is trading at around RM2.15 and the warrant is trading around RM 0.94. The warrant has a conversion price of RM 1.21 & will be expired in 2018. Mr A buy 1000 units of YTL Power (we call it the mothershare) & paid 2150. Using the same amount of money, Mr B buy 2287 units of warrant. 1 year later, YTL Power increase its value by 20% or trading at 2.58, at that time its warrant will worth 1.370 ( 2.58- 1.21 = 1.370). Mr A sell it and gain 430 or 20% while Mr B sell his warrant & gain 983 or a 46% return.
That's how warrant can leverage your return in investment, the same share or the same company you invest in but different instrument you invest through the return is different. Besides that, just remember leverage your return at the same time also leverage your risk.

I bought YTL Power warrant when it was trading at 0.64 & its mother share was trading at 1.85. The price of both now is 0.96 & 2.15( around that) now. My investment in YTL Power has give me an increase in value of a perfect 50% while the mothershare only increase 16% in value.

There are more i wanna share in warrant, which will be covered in my following posts.

"While most people say YTL Power is a very slow moving share and it's only for old man, i get a 50% return on investment from it in 3 months"