One of the biggest appeals of warrants is their leverage effect. A much smaller capital can be used to earn an enhanced rate of return. Some investors would then ask how could they use warrant to earn a return similar to that from holding the underlying stock? How many units of a particular warrant on the same underlying should they buy? There are 2 ways to approach this.

Method 1: Delta

We can estimate the number of warrants the investors need to buy through the warrant's delta.

Let's assume that investors want to earn approximately the same return from holding 2,000 units of the underlying and the delta of the relevant warrant is 0.5 with a conversion ratio of 1 to 1. To calculate the number of warrants the investors need to buy, they should divide the number of units of the underlying by the warrant's delta to earn the target return.

Number of the warrant required

= Number of units of the underlying / Delta of the warrant= 2,000 units / 0.5

= 4,000 units

Method 2: Effective Gearing

Using the effective gearing method, investors can estimate the dollar amount they should invest in the warrant in order to earn a gain mirroring that of investing directly in the underlying.

Assuming they want to reap a return similar to that of a $100,000 investment in the underlying and the effective gearing of the warrant is 10 times. The investors should divide the investment amount by the warrant's effective gearing in order to achieve the targeted return.

Amount invested in warrant

= Investment amount in the underlying/Effective gearing

= $100,000 / 10= $10,000

Investors should be aware that delta and effective gearing are not constant.

The figures calculated are estimates based on the assumption that all other factors remain the same, for example, no changes in implied volatility and other market factors.

The article is contributed by SG Securities (HK) Limited.

(HK Edition 05/15/2008 page3)