Warrant

Warrant is a derivative instrument. A warrant gives the right to its holder to buy the underlying from the company/issuer at a predetermined price on a predetermined date. Like options it also has a lots size. Warrants are listed and traded on the bourses. Simply speaking it is more like an Out of the Money Call option.

Recently, HDFC came out with its Warrants issue. This is the third of its kind by HDFC. The first one was issued in 2009 and matured in 2012 and second one was in 2015 and matured in 2018. The current one has following characteristics:

Strike Price:        2165

Issue Price:         180

Tenure:              3 Years

Lot Size:             600

There are multiple trades that can be built around it.

Directional Trade

If one is positively inclined towards the stock, can build position using Warrants. Being a 3-year product it can gives a decent duration for a mid to long term investment. The cost would be much lower than the cost of owning the stock. For instance, currently the warrant is quoting at Inr 300/-. This is 20% the price of underlying. Thus, one gets exposure of the stock without any issues around rollover or mark to market. The important thing here is to price it well, otherwise inspite of an upmove in the underlying one would not be able to make returns.

Replacing Stock with Warrants

For existing stock holders, they can replace their existing holding by warrants. This releases investible cash. For instance, by selling the underlying at around Inr 1800/- and buying the warrant at Inr 300/-, there would be an investible excess of Inr 1500/-. Assuming 6% returns on it, the returns over next 3 years would be able to cover a large of the cost of acquiring the warrant. However, the issue here is the delta would be less so one would not get the best of the upside in the underlying. Also, if the stock ends between the Sell Price and Strike Price one ends up missing the upside. Pricing it correctly is important here as well.

Leverage and Replacing the Stock

For existing shareholders who are extremely bullish on the stock can sell the existing holding and invest all or large part of it in the warrant. This gives them much bigger exposure, nearly 5x of the current exposure into the stock. But clearly higher exposure means higher risk as well. If the returns can be high so can be the losses.

Covered Call

One can buy the warrant and against that can write Out of the Money Call options. The benefit here is the significantly higher RoI, this is because the investment is of the warrant, while the premium will be calculated on the underlying price. For instance, a 2000 Call quoting at Inr 6/-, translates to just 0.3% absolute RoI on underlying but 2% absolute RoI on the warrant.

Clearly, if priced correctly, warrants have the ability to give superior returns as one gets much more time than a normal option.

Happy Trading!!!

Cheers.