What You Can Invest In
Covered Warrants
Warrants are not suitable for everyone. You should not deal in warrants unless you understand their nature and the extent of your exposure to risk. You should be satisfied that they are suitable for you in the light of your circumstances and financial position. The following summary cannot disclose all the risks and other significant aspects of warrants. You should not buy a warrant unless you are prepared to lose all of the money you had invested plus any commission or transaction charges. If you are in any doubt you should consult an appropriately qualified financial advisor.
1. Leveraged Returns
Leveraged returns are a major advantage of warrants but can also work against investors. Warrant investors should be aware that, if the underlying instrument to the warrant moves in the opposite direction to that anticipated by investors, the losses incurred by the warrant will be greater in percentage terms than those incurred by the underlying itself. The prices of warrants can therefore be volatile.
2. Limited Life
Warrants have a limited life, as denoted by the expiry date of each issue. After this date, warrants can no longer be traded or exercised. It is therefore important that the forecast move in the underlying instrument of the warrant take place during the life of the warrant. It must also be noted that warrants experience time decay (erosion of their time value) throughout their life. The rate of this decay accelerates as warrants near expiry and warrants may expire worthless.
3. Secondary Market Risk
Secondary market risk is the risk that investors may not be able to buy or sell a warrant at the desired price. The London Stock Exchange (LSE) requires UK warrant issuers to make markets (i.e. be present in the market with bid and ask prices) for their warrants, from issue to expiry so as to promote liquidity. The UK warrant market will be notable for the tightness of its spreads relative to other geared equity products.
4. Currency Risk
This is a concern when investing in warrants over international underlyings. The foreign exchange rate will affect the price of warrants over international equities as it is determined in the local currency of the underlying and then converted into £ sterling. For index warrants over international indices, foreign currency risk arises as the index multiplier (i.e. the value given to one index point) is denominated in the local currency of the index.
5. Counterparty risk
Unlike shares, SG may be the only market maker in SG warrants, meaning an investor is exposed to the risk of SG ceasing to trade SG warrants. Under normal market conditions SG will endeavour to provide a market making service. Such arrangements may be temporarily or indefintely be curtailed as a result of technical problems within companies of the SG group or data vendors or telecommunication carriers, or in the event of pending announcements by or difficulties in procuring information on underlying companies.
6. General Market Risks
Warrant prices are affected by general market risks like the prices of other stock market investments. Factors such as movement in local and global markets, interest rates, currencies and implied volatility have an impact on the price of warrants. Investors should be aware that the return on warrants:
- May be zero and investors may lose all of their purchase price; and
- Will not reflect the return investors would realise if they actually owned the underlying security and received the dividends paid.
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