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What You Can Invest In

Covered Warrants

• Introduction
• The underlying security
• The strike or exercise price
• The conversion ratio or parity
• The expiry date
• Exercise and settlement
• Warrants vs options

Introduction

Warrants cost a fraction of the price of their underlying security and give the buyer the right (but not the obligation) to buy ("Calls") or to sell ("Puts") this underlying security at a predetermined price (the Strike or Exercise Price) on or before a predetermined date (the "Expiry" or "Completion" Date).

The underlying securities can be shares, baskets of shares, commodities, international currencies or share price indices. The act of using the right given by the warrant is referred to as "Exercise". Warrants are classified as either American or European style, meaning that they can be exercised at any time during the life of the warrant (American style) or only on the expiry date (European style).

Warrants are part of the family of Securitised Derivatives as their value depends on the value of the underlying security. As such, the warrant investor gains economic exposure to this underlying security without actually owning it. Some key differences distinguish covered warrants from exchange-traded options and company-issued warrants:

• Covered warrants are issued by financial institutions such as SG, Goldman Sachs and Trading Lab who define the characteristics of each warrant. They are listed on the London Stock Exchange (LSE) and are settled via CREST in the same way as an ordinary share.
• Covered warrants cannot be short sold.
• Exchange Traded Options are traded on the London International Financial Futures Exchange and cleared through London Clearing House (LCH). Investors can short sell (write) options giving a potentially unlimited liability and can be obligated to make margin payments. Exchange Traded Options tend to have a shorter maturity than covered warrants.
• Company warrants are issued by companies on their own shares to raise equity capital. Upon exercise, the company will issue new shares. Both choice and liquidity are patchy in these instruments.

As the terms of each covered warrant are unique, it is important to read the Term Sheet of each warrant, available on this site. However, there are certain standard terms, which must be understood prior to investing in warrants.

The underlying security

The underlying security is the security over which the warrants are issued. The performance of this security is one of the key elements in determining the value of the warrant. SG is a leading issuer of warrants around the world, active in 15 different markets and today has one of the most extensive product ranges available.

The strike or exercise price

The strike or exercise price is the price at which the warrant holder has the right to buy (in the case of a call warrant) or sell (in the case of a put warrant) the underlying security. In response to market trends, SG continually updates its product range to provide investors with a choice of warrants by offering new strikes and maturities. The exercise price is fixed in the initial terms and conditions of the issue but can be adjusted following a corporate action by the underlying company, i.e. as a result of a share split. For further information, full adjustment details are given in each pricing supplement.

The conversion ratio or parity

The conversion ratio is the number of warrants required to control one unit of the underlying security. For example, a conversion ratio of 10:1 on a call warrant of AstraZeneca means that the warrant buyer needs to buy 10 warrants in order to gain exposure over 1 AstraZeneca share.

In general, SG warrants on a share price that is below 1000p (such as Vodafone) will have a parity of one and on a share above 1000p (such as AstraZenecca) a parity of 10:1. SG warrants on the FTSE100, for which one index point = 1GBP will generally have a parity of 1000-1.

While trading prices are quoted on a per warrant basis, the exercise price is quoted with reference to the underlying security (or securities). It is therefore important to know the conversion ratio before investing. The conversion ratio of a warrant may be adjusted following a corporate action by the underlying company, e.g. as a result of a capital reconstruction. For further information, full adjustment details are given in the Pricing Supplement.

The expiry date

The expiry date is the date on which the right to exercise lapses or, for cash settled warrants, the right is automatically triggered for in-the-money warrants.

Exercise and settlement

To exercise a warrant means to exercise the rights attributed by the warrant. Hence, when a warrant holder exercises a call warrant, it means that he wants to buy the underlying security at the exercise price from the issuer. Alternatively, when a warrant holder exercises a put warrant, it means that he wants to sell the underlying at the exercise price to the issuer.

Warrants vs options