Beware of demand overpricing warrants
(HK Edition)
Updated: 2008-02-12 07:42

The Hang Seng Index tops the trading list for warrants turnover.

Its related warrants recorded about HK$133 million net outflow in a recent week.

Among these mostly traded warrants, some of them had a very high "placeout-ratio", meaning most of the warrants are in the possession of investors.

In Hong Kong, the ratio is released daily, and it indicates the number of warrants sold to the market.

This presents an obvious question: What happens when warrant demand is strong and the placeout-ratio is very high?

Although this is not a common occurrence, it does happen. When the placeout-ratio of a particular warrant is relatively high (usually 70 percent or above), an issuer's ability to market his warrant deteriorates as the placeout percentage climbs.

Market forces could push the warrant price way above its "fair value" for a period. As in the case of an over-valued asset, an over-priced warrant will eventually return to its fair level. More importantly, as a warrant has a limited life span, the passage of time will force the warrant price to correct even faster. And when it does, the investing public who bought the warrant at the higher level can lose money.

Although not required by rules or regulations, some issuers believe it is important for the investors to be alerted when the placeout of a warrant is approaching a relatively high level. An issuer in general wants the investing public to be cautious in advance so that they pay more attention when evaluating a warrant price (i.e. the implied volatility) and avoid "chasing" when the warrant price might have already deviated from the mother share's performance.

Thus, when market demand outweighs supply, a warrant could be pushed to an over-priced level. Such over-pricing or deviation does not stay long, so investors should pay attention to information such as the placeout-ratio when evaluating if such a warrant is suitable for his or her investment portfolio.

SG Securities (HK) Limited provided article.

(HK Edition 02/12/2008 page3)