Investing in warrants means having a right to buy or sell the corresponding underlying shares at the exercise price. Regardless of whether to subscribe or sell, this right is valuable only when the exercise price has an advantage or may have an advantage over the spot price.
1. Pricing a possibility
Warrant investors are aware of the concepts of in-the-money, on-the-money and out-of-the-money, that is, for a subscription warrant, if the exercise price is lower than the spot price, it is called in-the-money, if it is equal to the spot price, it is called on-the-money, and if it is higher than the spot price, it is called out-of-the-money; put warrants are just the opposite. For example, for a call warrant with an exercise price of 5 RMB, if the spot price is 7 RMB, the warrant is obviously valuable. Even if the spot price is lower than 5 RMB, it does not matter. As long as it is not due, there is always the possibility of rising and it is also valuable in theory. From this point of view, the key to the value of a warrant is that it may become in-price, and this possibility changes every moment. All other factors can affect the warrant price because they directly affect the spot price.
In this way, whether calculating the theoretical value of the warrant or the market price, the starting point is to price the possibility of the underlying asset price breaking through the strike price in a favorable direction. Therefore, the warrant pricing becomes the pricing of a possibility. For this, there are two relatively mature theories in finance, the binomial model and the Black-Scholes option pricing model. Warrant issuers generally use this Operation on the basis.
In the Hong Kong market, since the issuer is responsible for maintaining market liquidity, the market price of the warrant is actually quite close to the theoretical value at that point in time. Therefore, we can look at the factors affecting the warrant price from the perspective of the warrant price.
2. Expiry time and volatility
The possibility of the underlying asset price breaking the strike price in a favorable direction is directly related to the length of time. However, it is worth noting that if this part of the value is called the time value, although the longer the time from the expiration date, the higher the time value, but as time goes by, the time value does not fall uniformly, the closer it is to the expiration date, the faster the time value will be lost, showing a non-linear accelerated decline. Investors familiar with the Black-Scholes option pricing model are well aware that the downward trend of the time value of warrants is actually closely related to the natural logarithmic curve.
Second, to price this possibility at a certain point in time, the volatility of the underlying stock price at that point must be considered, because the greater the volatility, the greater the possibility of becoming in-the-money. The measure of volatility is the magnitude of volatility, it is characterized by the standard deviation of the underlying stock price. The past standard deviation is called the historical volatility, and the future volatility inferred from the historical volatility is the implied volatility. The greater the implied volatility, the higher the warrant price, which is easy to understand, but it is worth noting that after a warrant is issued, the more volatile the stock price, the greater the implied volatility, and the more one-way smooth movement of the stock price, the smaller the implied volatility. This is actually related to the calculation method of standard deviation.
3. Interest rates and dividends
Changes in interest rates will also affect warrant prices. On the one hand, the warrant pricing formula involves a risk-free interest rate. The larger the parameter, the greater the warrant value in theory. On the other hand, the rise in interest rates will affect market sentiment, leading to fluctuations in underlying stock prices. In comparison, the impact of interest rate changes on the risk-free interest rate parameter in the pricing formula is not important.
Dividends will also affect the warrant price, because dividends will cause the ex-rights and ex-dividends of the stock price, which directly affects the price of the underlying stock. Another factor that may affect the price of a warrant is the amount and quantity or percentage of "Outstanding Quantity", which is often expressed as the proportion of a warrant held by investors other than the issuer. The greater the proportion of "Outstanding Quantity", the more active the transaction and the better the liquidity. But it is worth noting that the greater the proportion of "Outstanding Quantity", the greater the influence of the warrant on the sentiments of market holders, and the greater the deviation from the theoretical value.
The last thing worth mentioning is the leverage ratio. The reason why most investors buy warrants is that a little change in the underlying stock price can bring about large fluctuations in the warrant price, and when the underlying stock price changes 1%, the magnitude of the warrant price change is proportional to the actual leverage. The calculation method of actual leverage is relatively simple, and it can be carried out by the following formula: actual leverage = (underlying stock spot price × conversion ratio) ÷ warrant price × hedge value. However, it should be noted that the greater the actual leverage, the greater the profit may be, but the greater the risk.
