Covered Warrants - The Not So Silent Killer

by Salvador Dali

One should never never punt on warrants with less than 1 year to expiry, especially covered warrants. I can safely bet that anyone who trades in covered warrants in the course of a year will have a 90% chance to sustain losses. 

Unfortunately, our markets have been in the doldrums for the past 6 months or so and that has caused some die hard players to only consider covered warrants, esp those index covered ones, in particular the highly volatile HSI covered (which kind of acts as a proxy to the even more volatile China exchanges).

Just have a look at the daily volume rankings, its always the covered warrants for the past few months. Strange as it may seem, if things continue, our local exchange will be trading mostly other countries' covered index warrants for the longest time - esp if the big guys introduce the Nikkei covered as well.

Why investors will lose big in the long run:

1) Time Value - These covered warrants are usually short in terms of time to expiry, usually less than 12 months. Investors are usually lured into covered warrants when their absolute price are less than 30-40 sen because they think they get a lot of leverage. But to get to 30-40 sen, it also usually meant that there is less than 6 months to expiry, and trust me, the time value diminishes rapidly. Even if the linked product stays stationary, you will find the price of the CW dropping.

2) Your opponent - Unlike a company's warrant, in CWs there are teams of experienced traders (issuers) with sophisticated models fighting you on the other side. If you think the role of issuing house is to MANAGE their gammas and betas, YOU'D be very wrong. The safest way to make money for issuers is just to manage and capture the premium, manage free float, and make sure you are well hedged. MUCH LIKE THE CASINOS - they almost never ever lose... so guess who wins and loses in the end. Better to go Genting, seriously.

Even when you keep wanting to buy, they will keep giving you the volume to buy. They can keep throwing new shares at you as long as the equation is right. What you see on the screen being offered is never what they "really can sell" to you.

3) Volatility - The die hards will say they trade only the highly volatile CWs such as HSI. Yes, thats a better strategy but I can also tell you that the higher the volatility, the higher the premium that is priced into these CWs, and it will take a hefty whack in movement to erase the premium before you see good gains.

4) One Sided - You know very well the issuers KNOW you can only take ONE SIDE of the equation. So overtime you show up on the screen, either you are buying or buying. At any point in time, they know how many people are long or short out there. Imagine playing black/red, but you can only bet red and the odds are always 0.7 to one instead of 1 to 1.

5) Timing - The nature of the product necessitates the need to TIME your entry point accurately. So, unless you are the type that can walk between raindrops to avoid getting wet - fergedaboudit.

The next time you think of trading a CW... just picture the trading/hedging teams at the banks, you can almost invariably see them laughing and chuckling to themselves at how easy it is to make money from the market (that means you and me).


p/s my first 8 years of my career was spent placing, trading and managing the house book on Japanese corporate warrants for Nomura and James Capel

List of Listed Companies with –NTA (as at 08-12-2016)

List of Listed Companies with –NTA (as at 08-12-2016)

Code	Stock	NTA	Status	Remark
0141	WINTONI	-0.002	Active
0039	ASIAEP	-0.013	Suspended
0110	RA	-0.026	Suspended
0135	SCN	-0.0422	Suspended
7122	YFG	-0.08	Active
0022	CYBERT	-0.09	Suspended
8303	KFM	-0.16	Active
7002	NAKA	-0.28	Active
2887	LIONDIV	-0.29	Active
7027	PETONE	-2.073	Suspended
5146	PERWAJA	-3.50	Active	-3.50!!! Still there!!! Why ah?

The purpose of writing this article is to share my thinking of some observations on the companies listed above and the lesson that we can learn from it. First, see what you see before I highlight to you what I see. Just highlight, I don’t want to waste too much time to explain. I usually don’t like to write stocks that I’m not interested to own. I also don’t like to write article to ask to sell certain stocks, even though most of the time I’m able "to predict" the right timing to do so. 马后炮？哈哈哈！   

1.  High risk high return? Yes, sometime, but perhaps just once and definitely not all the time. When investing in stocks, to me, risks come first. Many retail investors don’t even know what’s the risk in their stock investment. Are you? But I’m very sure a lot of them don’t even bother to know about it. Take a look at the stock that has –RM3.50 of NTA per share. By the way, why such a company that should have gone bankrupt long long time ago and yet still traded actively until now?

2. What is the fair value of a stock? How to value a stock? Does the current price reflect its’ value? Is the stock undervalued or overvalued? What determine the price and who has the ability “to fix” price?

3. Pump and dump? What does it means? This kind of stock manipulation always happened. This is how some greedy and irresponsible individuals/parties make money at the expense of some innocent retail investors.

4. On NTA. What does it mean? What does it mean if price > NTA or price < NTA? You can think about it with the following examples:

0138 MYEG: P=2.23 > NTA=0.18 ( so good meh, another bonus issues coming soon)

6399 ASTRO: P=2.73 > NTA=0.113 (note: good dividend? take a look at capital and reserves)

6947 DIGI: P=4.98 > NTA=0.08 (why so many investors like this?)

5155 XINQUAN: P=0.11 < NTA=1.84 (a lot kena trapped here)

4596 SAPRES: P=0.925 > NTA=3.63 (look very interesting, but…)

6548 MPCORP: P=0.12 < NTA=0.50 (buy calls repeatedly come from someone)

5. On leverage. The amount of debt used to finance a firm's assets. Look at the balance sheet, 8 or 9 out of 10 GLCs and more than half of Bursa listed companies use this. The amount of debts used in most businesses getting bigger and bigger. The justification: growing business with borrowed money can make more profit and so the ROE can be made higher. Yes, some is, and only those genuining. The risk is on those who are not. How to know which one is and which one is not. Until a time that some cannot grow anymore with debt, or they find no way to borrow money or to roll old one with new one, then they come to the shareholders, the so-called de-leveraging/ restructuring: Rights issues , consolidation and rights issues, rights issues with free warrants, rights issues with bonus issues, private placements, backdoor listing, IPOs, etc.

Examples：

7143 Stone: last year rights issues with free warrant, now PN17.

1171 MBSB: 3 times rights issues within 5 years. Look at the liabilities side. Btw, there are few “buy calls” recently.

3876 MAS: 3 times rights issues before privatized by the govt.

0039 ASIAEP: Proposed Capital Reduction and Proposed Consolidation, Proposed Share Exchange (what is this???)

And many more to come. 

Ok, too many issues with many examples for us to think about it or to learn something from it. With these understandings, there is also no guarantee that you’ll make money from stock investment. Without these understandings, 钱亏了，还傻傻不知道发生什么事。Enough for this article. My plan for next article: My Stock Selection Based on NTA, EPS, and Expectation. Filter all and understand what cannot buy, then when the right timing come, you know what to buy. Just a plan, don’t know whether got time and mood to write to share or not. Stay tuned, anyway.      

Just for sharing.

By Bugle