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Options, derivatives, futures, warrants : what's the difference? In the case of options, derivatives and warrants, not much. Derivatives are, in fact, anything that is based on (i.e. derived) from something else. In the case of financial instruments, a derivative is an overall term that encompasses futures, options and warrants. A future is different; two parties agree to perform a trade in the future at a fixed price. It is not possible to decide at a later date whether to perform the trade or not. Warrants are a form of option; they give you the right to buy a share at an agreed price (strike price) at an agreed date in the future. They differ from a standard option in that their time to maturity is usually more than a year and is often issued by the company itself. A derivative's value is heavily dependant on the value of the underlying share. You can use our calculator to work out the connection. Warrants are a form of option; they give you the right to buy a share at an agreed price (strike price) at an agreed date in the future. Due to the gearing of warrants, any increase in the underlying share's value will cause a much greater increase in the warrant's price. When entering an order to buy a warrant, always specify a price. This is particularly important with order book driven systems (such as SWX Swiss Exchange); warrants are often not very liquid - this means that there may not be very many orders in the order book. If you enter an order at market, there is a good chance that your trade will be matched at a completely unrealistic price. A proportion of the price that you pay for a warrant is the time premium. This is the amount that the warrant costs over and above the cash in value. When you own a warrant, you will miss out on any dividends paid and on the corresponding gain in the share price. To calculate the Percent To Break-Even : percent = ((strikePrice + (derivPrice * numberNeeded) - underlyingPrice) / underlyingPrice) * 100 To calculate the Deriv Price : derivPrice = (((percent / 100) * underlyingPrice) + underlyingPrice - strikePrice) / numberNeeded
OVERVIEW
Options are a form of derivative; they give you the right to trade a share at an agreed price (strike price) at an agreed date in the future. You do not have to make this trade; if it is not in your interest then you can let the option lapse. Hence the name option.
You pay a price (the cost of the warrant) for this privilege. When the warrant expires, you can decide whether you want to buy the shares at the strike price or not.
If the price of the shares is below the strike price, then you will not exercise your right and you will have lost your initial capital.
However, if the price of the shares has risen above the strike price, you can buy the shares at the strike price. If you wish, you can sell the shares again immediately. Your profit is thus the difference between the current price of the shares and the strike price (minus the original cost of the warrant). Many warrants simply pay this difference out in cash.
For example, suppose that you buy a warrant for 50 Sfr with a strike price of 600 Sfr and the current share price is 620 Sfr. If the share price was then to rise 10% by maturity, your warrant would have a value of 82 Sfr (682 - 600). However, if the share price stayed the same until maturity, then the warrant would have a value of 20 Sfr (620 - 600).
Conversly, any fall in the share's price will create a large swing in the warrant's price. Bear in mind that if the share price should finish below the strike price, the warrant will have no value whatsoever.
This makes warrants very high risk. You should only invest money in warrants that you are prepared to lose.
Clearly the longer the time until expiry, the less risk is invloved with the warrant. However, you will also pay a higher premium for the extra time.
It is therefore essential to know roughly what a fair price is for the warrant, and also to enter your order with a price.
You can use this calculator to get an idea if the warrant price quoted is fair or not. For in-the-money warrants, the percent to break even should not be too high (10% per annum would be high). The calculator is written in JavaScript so that you can look at the formulas used. A future version will include a calculation of the Black-Scholes price and the implied volatility.
If the underlying stock stays at its current value until its expiry date, then the warrant's price will decrease to the cash in value. This means that the time premium will be lost.
This is an important point - the time value is the amount that you pay for the privilege of owning the warrant and the amount that you will lose should the underlying stay at the same price.
If all other factors remain the same then, as time passes, the warrant's value will slowly decrease.
The calculation Percent to Break-Even calculates the rise to the point where you break even in straight cash terms. The share price will, of course, need to rise further in order to break even when compared to buying the share instead.
This value is the percentage that the underlying must increase to break even.
The lower the value the better.
This value is the price of the derivative and the calculation can be used to ask "what if" questions. For example, you could change the underlying price and re-do the calculation to see what value the derivative would then have.