|
Warrant Product Working Group of Guotai Junan Securities New Product Development Department
1、 Basic knowledge of warrants
1. Definition and classification of warrants
Warrant is a contract between the issuer and the holder. The warrant holder has the right to buy or sell a certain amount of underlying assets at an agreed price at an agreed time. The underlying asset can be an individual stock, or a basket of stocks, indexes, commodities or other derivatives. This paper takes stock as an example.
Warrants can be classified according to different criteria: (1) According to the direction of exercise of rights, they are divided into call warrants and put warrants: the holders of call warrants have the right to buy the underlying stocks, and the holders of put warrants have the right to sell the underlying stocks. (2) According to the exercise period, it can be divided into European style warrants and American style warrants: holders of European style warrants have the right to buy and sell the underlying stocks only on the agreed maturity date, while holders of American style warrants have the right to buy and sell the underlying stocks at any time before the maturity date. (3) According to the issuer, it can be divided into equity warrants and covered warrants: equity warrants are usually issued by listed companies, and their exercise will increase the share capital of joint-stock companies. Covered warrants are issued by a third party (such as securities companies and other financial institutions) other than the issuer of the underlying assets, and the stocks they recognize are listed and circulating stocks, which will not increase the total share capital. (4) According to the relationship between the exercise price and the market price of the underlying stock, there are in price warrants, price parity warrants and out of price warrants. If the warrant holder immediately exercises the right to obtain income, it is called an in price warrant, otherwise it is called an out of price warrant. In particular, if the exercise price is equal to the market price of the underlying stock, it is called a level warrant. It is worth noting that a warrant is within the validity period, and may be in the price today, while it will be in the price or out of the price tomorrow.
2. Characteristics of warrants
1) Risk aversion: If an investor has held or is about to hold a position in the underlying stock, he or she can purchase warrants as a hedging tool. For example, if an investor predicts that the stock price is going to rise, but he or she is worried about the prediction error or in order to avoid systematic risk, he or she can use a small amount of money to buy a put warrant. When the stock falls, The part of its warrant profit can be used to make up the opportunity cost of buying the underlying stock. When the stock price rises, its purchase of the stock has made a profit, while the loss is only a small amount of warrant gold. On the contrary, if the investor predicts that the price of the subject matter will fall soon, the opposite hedging strategy can be implemented.
2) High leverage: Warrants are one of the derivative financial products. They only need to pay a small amount of royalties when trading. They are highly leveraged. The greater the leverage ratio, the greater the leverage effect, and the greater the risk of profit and loss; On the contrary, the smaller the leverage ratio, the smaller the leverage effect, and the smaller the risk of profit and loss.
3) Timeliness: Unlike stocks, investors can hold warrants for a long time when they buy or sell warrants. Warrants have a duration, and they lose their effectiveness when they expire. If the warrant does not have exercise value when it expires, the investor will lose the price of the original warrant.
4) The risk is limited and the profit is infinite: if the warrant has no exercise value or the holder does not apply for an agent before the expiration of the warrant, the maximum loss is only the premium paid for the original purchase of the warrant, so the risk is limited. Before expiration, if the price of the underlying asset rises, the price of the warrant will rise accordingly. Because the price of the underlying may rise indefinitely, the profit of the warrant is infinite. Even for the put warrant, its profit margin is far greater than the loss of the premium.
3. Determination of warrant value
Before expiration, the market price of warrants includes embedded value and time value.
The intrinsic value is the difference between the price of the underlying stock and the exercise price, that is, the value of immediate exercise of rights. As far as the warrant is concerned, the intrinsic value=the current price of the underlying stock - the exercise price; For put warrants, it is: intrinsic value=exercise price - current price of underlying stock. Assuming that the current price of the underlying stock is 100 yuan and the exercise price of the warrant is 80 yuan, the intrinsic value of the warrant is 20 yuan. In general, the value of warrants should be at least equal to its intrinsic value, and the intrinsic value of both price balanced warrants and out of price warrants is equal to zero.
Time value reflects the value of the underlying stock price that may change in favor of investors before the maturity date. It is mainly related to two factors:
(1) The length of the remaining term of the warrant.
For call (put) warrant investors, the longer the time from the maturity date, the greater the possibility that the underlying stock price will rise (fall) to further profit, and thus the greater the time value. As time goes by, even if the investor judges the future trend of the underlying asset correctly, the time value will decrease with time, thus affecting the value of warrants. Generally speaking, when the warrants are just issued, the time value will not decline too much over time, but after half of the duration, the time value will decline rapidly, and in the last month, the range and speed of decline will increase. Therefore, if the warrant investor judges that the probability of the warrant becoming in the price within the remaining time is extremely small, he should generally sell the warrant as soon as possible to avoid losing the time value in vain. Of course, at this time, the value of the warrant is low, and investors with greater risk appetite can also make full use of the extremely high leverage at this time to obtain the earnings of the subject stock price soaring (or plummeting).
(2) Volatility of the underlying stock.
Whether it is a call or a put warrant, the increase in the volatility of the underlying stock will increase the opportunity for warrant holders to make profits. Therefore, the greater the volatility of the underlying stock, the higher the value of the call and put warrants. Volatility is generally expressed as a percentage to measure the volatility of the underlying stock price.
Generally, there are two kinds of volatility, historical volatility and implied volatility. The historical volatility is calculated based on the historical price of the underlying stock, reflecting the past volatility of the underlying stock. However, because it is difficult to predict the fluctuation of stock price, the prediction using historical volatility can not guarantee accuracy. The implied volatility is calculated by substituting the market price of warrants into the theoretical price model of warrants. The issuer or market maker of warrants generally quotes warrants based on the implied volatility reflecting market supply and demand. Historical volatility can only be used as a reference for volatility, which is generally not equal to implied volatility.
In warrant practice, the Black Scholes model (BS model) is widely used for warrant pricing. It concludes that the pricing formula of warrants is:
Value of warrant:,
Put warrant value:,
Among them;
N (x) is the cumulative probability of standard normal distribution, representing the probability that the occurrence result is less than x.
It can be seen from the formula that the warrant price is determined by five variables, including the underlying stock price S, the exercise price K, the risk-free interest rate r, the residual maturity T-t and the underlying stock price volatility σ. The effect of changes in these five variables on the price of warrants is shown in the following table:
Table 1.3 Factors Influencing Warrant Price Influencing factors Change in call warrant price Change in put warrant price Target share price ↑↑↓ Exercise price ↑↓↑ Remaining period ↑↑ ↑ Risk free interest rate ↑↑↓ Volatility of underlying stock price ↑↑ ↑
The level of risk-free interest rate can be understood as the cost of financing and investing in the underlying stocks of warrants. The higher the interest rate level, the higher the cost of investing in stocks, so the call warrants become more attractive, while the put warrants become less attractive, so the price of the call (put) warrants will be higher (lower).
2、 The Application of Warrants in Split Share Structure
There are three ways to use warrants to solve the split share structure problem.
1. Idea 1: Present warrant to circulating shareholders
The holders of non tradable shares, taking non tradable shares as the subject matter, shall send corresponding number of warrants free of charge to the holders of tradable shares, and shall adopt the method of stock settlement upon expiration. The circulating shareholders can transfer their warrants or exercise their rights to obtain profits, while the non circulating shares can gradually obtain the circulating rights. The value of the warrant is the consideration paid by the holders of non tradable shares.
The exercise price of the warrant can be determined according to the specific conditions of the underlying stock. The shares obtained by the holders of tradable shares after exercising their rights can be immediately circulated. There are two ways to determine the number of shares that the holders of non tradable shares have the right to circulate and the limit of the period of circulation: one is that only the non tradable shares that the holders of tradable shares have the right to exercise can be circulated; Second, after a certain number of warrants are presented, a corresponding number of non tradable shares (for example, all non tradable shares) have the right to circulate and cannot circulate within a certain period and under certain conditions (for example, within 12 months or the share price is below a certain level). The problem that may exist in this way is that non tradable shareholders have incentives to depress the share price: the warrant is out of the price when it expires, so the exercise value is 0.
2. Idea 2: Giving put warrants to circulating shareholders
Non tradable shareholders shall send corresponding number of put warrants to each tradable shareholder free of charge. When exercising the warrants, cash shall be settled according to the difference between the exercise price and the current share price, or converted into shares according to the ratio of the difference and the current share price and sent to the tradable shareholders. After the listing of warrants, the corresponding number of non tradable shares will obtain the right to circulate.
Similarly, the exercise price of the put warrant can also be determined according to the specific situation of the underlying stock. The problem with this scheme is that the shareholders of tradable shares have incentives to depress the stock price: the lower the stock price, the higher the value of put warrants.
3. Idea 3: Give the combination of call warrants and put warrants to circulating shareholders
The approach of this idea is: non tradable shareholders issue call warrants with part of their own shares pledged, and issue put warrants with performance bond pledged. Then, in a certain proportion, the call warrants and put warrants will be presented to the circulating shareholders free of charge, and the corresponding number of non tradable shares will obtain the circulation right. The scheme stipulates that the warrant holder can purchase the shares held by the original non tradable shareholders at the exercise price of the warrant within the validity period of the warrant; The warrant holder may also sell his shares to non tradable shareholders at the exercise price of the put warrant within the validity period of the warrant. Warrant holders may trade their warrants in the market or exercise their rights. The consideration paid by non tradable shareholders to tradable shareholders is equal to the sum of the values of call warrants and put warrants.
For example, the total share capital of listed company A is 3 billion shares, including 2 billion non tradable shares and 1 billion tradable shares. The stock price is 10 yuan, and the historical volatility of the stock price is 30%. In order to obtain the circulation right, the holders of non tradable shares have introduced the following scheme: 2 put warrants and 2 call warrants will be given for every 10 tradable shares, and 2 billion non tradable shares or circulation rights will be given. The warrant terms are as follows:
1) Call warrant 2) Put warrant Warrant type: European Warrant type: European Duration: 12 months Duration: 12 months Exercise price: 10 yuan Exercise price: 9 yuan Exercise ratio: 1:1 Exercise ratio: 1:1 Settlement method: stock settlement Settlement method: cash settlement
Under this clause, the value of each warrant is about 1.43 yuan; The value of each put warrant is about 0.69 yuan. The consideration paid by non tradable shareholders at the beginning of the period was about 424 million yuan. The value of warrants granted to shareholders of tradable shares at various stock price levels is shown in Figure 2.3. As long as the share price is higher than 10 yuan or lower than 9 yuan, that is, whether the share price rises or falls, as long as the market fluctuation is large enough, the shareholders of tradable shares can make profits.
Figure 2.3 Change in value of warrants
If the shareholders of non tradable shares and tradable shares can't make a correct judgment on the future trend of share prices, and the market volatility is relatively large, the scheme of matching call warrants and put warrants is beneficial to both non tradable shares and tradable shares. As shown in Table 2.3, when the stock price fluctuates greatly, if the holders of non tradable shares cannot judge the future trend of the stock price, the matching scheme can make them pay a smaller consideration. For the holders of tradable shares, if they cannot judge the future trend, the scheme of matching call warrants and put warrants can also reduce their risks. Otherwise, if the scheme of call warrants or put warrants is adopted, once the direction is judged wrong, nothing may be obtained at the expiration. Another advantage of the collocation scheme is that it can restrain the impulse of non tradable shareholders or tradable shareholders to manipulate the share price. For a separate subscription or sale, both parties have incentives to raise or lower the share price in order to obtain income. The appropriate combination of programs can appropriately reduce this incentive.
Table 2.3 Consideration and Stock Price Changes
3、 Advantages of warrant scheme in share splitting
1. Non tradable shareholders are not sensitive to time value, and investors are easy to obtain greater profits
As mentioned above, the warrants granted to the holders of tradable shares include intrinsic value and time value. For example, the intrinsic value of warrants is that the exercise price of warrants is lower than the transaction price of regular shares, that is, warrant holders can purchase regular shares from holders of non tradable shares at a lower price than the market price, This directly reflects the consideration paid by the holders of non tradable shares to the holders of tradable shares in order to obtain the circulation right. The holders of non tradable shares are more sensitive to this part of value, while the holders of non tradable shares are less sensitive to the time value.
For example, for a certain warrant, the market price of the regular shares is 5 yuan, the exercise price is 4 yuan, and the term is 1 year. For the holders of non tradable shares, he believes that the consideration paid is 1 yuan, but for the holders of tradable shares, the consideration obtained is far more than the intrinsic value of the warrant 1 yuan, and there is a one-year time value. Assuming that the volatility of the regular shares is 30%, the time value of the warrant is 0.35 yuan, If the warrant is created by the securities firm through dynamic hedging means, considering the necessary cost and risk compensation, its price may be 1.5 yuan. Therefore, the cost of such a warrant given by non tradable shareholders to tradable shareholders is 1 yuan, but the value of the warrant received by tradable shareholders is 1.5 yuan.
It is precisely because the non tradable shareholders are insensitive to the value of time that the tradable shareholders will be able to obtain greater benefits when receiving consideration, and also make the negotiation between the non tradable shareholders and the tradable shareholders in the equity division easier.
2. The packaged distribution of call warrants and put warrants makes it easier for investors to obtain greater returns
In order to obtain the circulation right, the holders of non tradable shares distribute the call warrants and put warrants to the holders of tradable shares at the same time. In their opinion, it is less likely that the call warrants and put warrants will be exercised at the same time, that is, in their opinion, the consideration they pay is only the larger value of the call warrants and put warrants, while for the holders of tradable shares, Since the call warrant and put warrant obtained by him can be sold separately, in his opinion, the consideration obtained is the sum of the call warrant and put warrant.
For example, taking the example of Train 3 above, the value of each warrant is 1.43 yuan, and the value of each put warrant is 0.69 yuan. The circulating shareholders can sell two types of warrants or any of them to gain profits. For him, the consideration obtained is 2.12 yuan. At this moment, for the non tradable shareholders, he thought the consideration paid was 1.43 yuan.
It is precisely because the value of the same combination in the eyes of non tradable shareholders and tradable shareholders is not equal, which makes it possible for tradable shareholders to obtain greater consideration, thus making the share trading scheme of warrants easier to pass.
3. Warrants provide possibility for consideration marketization
In many previous schemes, the consideration paid by the holders of non tradable shares is basically determined by the holders of non tradable shares. If the holders of tradable shares do not accept it, they can only vote against it to prevent the split of shares or sell shares after the scheme is passed, which is very unfavorable to the stock market and investors.
Due to its unique contractual arrangements and value composition, warrants can provide a bargaining channel for shareholders of tradable and non tradable shares. Because it is difficult to determine how much consideration the non tradable shareholders should pay to the tradable shareholders in exchange for the circulation right, the best way is to price it by the market, and the warrant just provides such a possibility. The market value of warrants can be reflected in the transaction process in the secondary market, which will fully reflect the market-oriented principle of consideration payment.
4. Profit from selling warrants does not impact the equity
In the previous stock dividend scheme, the consideration received by the holders of tradable shares was mainly the shares donated by the holders of non tradable shares. In order to cash in this consideration, the holders of tradable shares must sell their shares in the secondary market, which will inevitably cause a sharp decline in shares（ information quotation forum ）An obvious example is the 35% drop in the two trading days after the listing and circulation of the donated shares. As a result, the consideration obtained by investors has shrunk significantly, which is not conducive to the split share structure.
For the reform plan of paying warrants, if the shareholders of tradable shares want to cash in the consideration they have obtained, they only need to sell warrants in the warrant market, and will not have a significant negative impact on the secondary market of regular shares. In addition, even though warrants will have the effect of diverting funds, because their prices are low, the effect of diverting funds will be far less than that of direct share delivery.
In addition, if the warrants are presented or sold to the management, it will be beneficial to combine the interests of the management with the interests of the shareholders of tradable shares or even all shareholders in the future. If they hold warrants that expire and exercise their rights to obtain shares, they can further improve the incentive mechanism of listed company governance.
4、 Investment strategy of warrants
Warrants can not only play a role in the split share structure, but also contribute to the reform. For investors, warrants have a special role that other investment tools cannot match in the transaction of the warrant market. Next, we will illustrate the trading strategy of warrants through some specific cases to appreciate the unique charm of warrants.
For the sake of uniformity, the subject matter of the warrants involved in the cases in this chapter is SSE 50（ information quotation forum ）The specific elements of ETF are shown in Table 4.1.
Table 4.1 Specific Components of SSE 50ETF Call and Put Warrants Target current price strike price strike ratio volatility interest rate term warrant price Call warrant 0.8 yuan 0.8 yuan 100 30% 6% Three months 5.37 yuan Put warrant: 0.8 yuan 0.75 yuan 100 30% 6% Three months 2.17 yuan
1. Use high leverage to obtain higher returns
When the warrant is traded, only a small amount of premium must be paid to obtain the income of the underlying assets. The premium is generally only a small proportion of the price of the underlying asset, so the warrant is highly leveraged. The leverage ratio can be used to measure the leverage of warrants.
Leverage ratio=underlying stock price ÷ (warrant price ÷ exercise ratio).
The greater the leverage ratio, the greater the leverage effect.
Case 1 assumes that the current price of the SSE 50ETF is 0.8 yuan. Lao Li, an investor, is optimistic about the trend of the SSE 50 index in the next three months. He can have two investment options:
(1) Direct purchase
Lao Li directly purchased 10000 50ETFs of SSE with a total of 8000 yuan;
(2) Investment in SSE warrant
To enjoy the benefit of the rise of 50ETF of 10000 SSEs, Lao Li can also choose to invest 100 warrants, which only requires 537 yuan of capital, and the leverage ratio is 0.8 ÷ (5.37 ÷ 100)=14.90 times.
Suppose that one month later, the price of 50ETF of SSE rises to 0.90 yuan. According to the pricing formula of warrants, the price of warrants is about 11.59 yuan. Direct investment in ETF, with a yield of 12.5%; The yield of investment warrant is (1159-537) ÷ 537=115.83%.
If investors misjudged, the ETF price fell to 0.70 yuan. Direct investment 50ETF, loss 10000 × (0.8-0.7)=1000 yuan; The biggest loss of investment warrant is the premium of 537 yuan.
The profit and loss comparison chart of the two investment decisions is as follows:
Figure 4.1 Profit and loss comparison between ETF investment and warrant investment
2. Self constructed principal guaranteed financial products
Warrant is a basic derivative product. Securities companies can develop many different derivatives by using warrants. In fact, with warrants, investors can also design their own products for asset management through the combination of warrants, bonds and other financial instruments according to their different risk return preferences.
Case 2 Lao Zhao is a very conservative private entrepreneur. He now has a working capital of 10 million yuan. He hopes to make capital guaranteed investment for three months, but he hopes to get a return rate that exceeds the current market interest rate. In addition, suppose that there is an A bond with the remaining three months in the market, and the annual yield to maturity is 4%. According to Lao Zhao's requirements, we can build the following combinations:
(1) 9.901 million yuan of investment bonds;
(2) The amount of investment warrant is 99000 yuan.
The income to maturity of Lao Zhao is shown in the table below:
Table 4.2 Maturity profit and loss of principal guaranteed products constructed with warrants and bonds Scenario 1: ETF rises to 0.95 yuan Scenario 1: ETF falls below 0.75 yuan The value of the bond part (10000 yuan) 990.1 × (1+4% ÷ 4)=100 990.1 × (1+4% ÷ 4)=1000 The value of warrants (10000 yuan) 9.9/5.37 × (0.95-0.8) × 100=27.65 0 Total asset value (ten thousand yuan) 102765 1000 Yield (1027.65-1000)/1000=2.77% 0 Equivalent annual yield 11.08% 0
It can be seen that even if the market falls, the principal of investors is still guaranteed. Through such methods, investors can achieve the investment goal of maximum return while controlling risks. This combination is the embryonic form of the capital guaranteed fund that is popular today. Of course, investors can obtain various risk return portfolios by controlling the proportion of funds to purchase warrants, such as the maximum loss of 2%, 5%, 10%, etc.
The above is the application case of call warrants. Let's take a look at the example of put warrants.
3. Hedging securities in position
If the investor has held the spot, in order to prevent the spot from falling and suffering huge losses, he can purchase the corresponding put warrant as a hedging tool.
Case 3 An investor, Lao Zhang, expected that the Shanghai Stock Exchange 50 Index would rise in the next three months, so he bought 1 million 50ETFs at a price of 0.8 yuan, but he was worried about the prediction error, so Lao Zhang could buy 10000 Shanghai Stock Exchange 50ETF put warrants, and the following situations would generally occur:
Table 4.3 Profit and loss analysis of spot portfolio with hedging ETF price (yuan) 1.0 0.85 0.72 0.6 ETF profit and loss (10000 yuan) 20 5 - 8 - 20 Gains and losses of warrants (10000 yuan) - 2.17 - 2.17 0.83 12.83 Total profit and loss of spot portfolio (10000 yuan) 17.83 2.83 -7.17 -7.17
It can be seen that through this hedging operation, investors can lock in the maximum loss even though they have paid a certain amount of extra cost (usufruct), and the cash they hold can still enjoy normal profits. In fact, it can be clearly seen from Lao Zhang's portfolio profit and loss chart that Lao Zhang actually constructed a warrant with limited losses and unlimited returns by paying a certain cost.
Figure 4.3 Profit and loss chart of spot portfolio with hedging
4. Convert relative income into absolute income
There are many investors in China who have advantages in the choice of securities, and their choice of securities can often exceed the index. However, as an emerging and immature market, China's securities market has a large proportion of systematic risk in investment risk. Investment is often scarred by the inability to avoid huge systemic risks. This is also the reason why most institutional investors can only take the beyond index as the standard of performance evaluation, but cannot promise absolute returns.
However, if we use put warrants, we can convert relative returns into absolute returns.
Case 4 An institutional investor has been very successful in selecting individual stocks, and the relative yield can exceed the Shanghai Stock Exchange 50 Index by 10%. Suppose that now it has purchased a portfolio A of 7.5 million yuan and 100000 ETF put warrants (with a cost of 217000 yuan). When it expires, the following situations may occur:
Table 4.4 Analysis of Profit and Loss from Relative Income to Absolute Income ETF variation range (%) 10 - 10 - 20 - 30 Profit and loss of portfolio A (10000 yuan) 150 0 - 75 - 150 Profit and loss of put warrants (10000 yuan) - 21.7 8.3 88.3 168.3 Total profit and loss (10000 yuan) 128.38.3 13.3 18.3 Total yield (%) 16.63 1.08 1.72 2.37
It can be seen that even if the market drops sharply, investors can still obtain an absolute return rate greater than zero.
5. Gains from sharp rises and falls -- saddle warrant portfolio
In some cases, investors can judge that the market is about to fluctuate significantly, but they are not clear about the direction of market fluctuations. Then investors can buy put warrants and call warrants based on the same underlying asset at the same time, and enjoy the profits brought by the market fluctuations while controlling the maximum risk.
Case 5: Lao Liu, an investor, judged that the market would be affected by a policy in the next three months, and the index would rise or fall sharply, but the specific direction of change was unclear. So Lao Liu spent 5.37 yuan to buy a call warrant and 2.17 yuan to buy a put warrant. When the warrant expires, the return of the warrant portfolio is as follows:
Table 4.5 Profit and loss analysis of saddle warrant portfolio ETF price (yuan) 1 0.9 0.8 0.7 0.6 Net income from warrants (10000 yuan) 14.63 4.63 -5.37 -5.37 -5.37 Net income from put warrants (10000 yuan) - 2.17 - 2.17 - 2.17 2.83 12.83 Total income (10000 yuan) 11.46 1.46 -7.54 -2.54 7.46
It can be seen that as long as the underlying asset changes significantly, whether up or down, Lao Liu's warrant portfolio will be profitable, and the greater the change, the higher the return; However, if the underlying assets are subject to consolidation, Lao Liu will suffer a certain loss, and the maximum possible loss is the premium of two warrants. The profit and loss chart of the saddle warrant portfolio is as follows:
Figure 4.5 Profit and loss chart of saddle warrant portfolio
Since the profit and loss chart of this warrant portfolio is similar to a saddle, this portfolio is called a saddle warrant portfolio (also known as a straddle warrant portfolio).
6. More complex warrant trading strategies
If the warrant market has a certain scale, the market products are relatively rich, and there is no short selling restrictions, the trading strategies of warrants will be colorful, dazzling and stunning. A butterfly spread warrant portfolio introduced below is a vivid example.
Figure 4.6 Profit and loss chart of butterfly spread warrant portfolio
The butterfly spread warrant portfolio consists of three different exercise prices of the same type of warrant positions of the same underlying asset: purchase a warrant with a lower exercise price X1, purchase a warrant with a higher exercise price X3, and sell two warrants with an exercise price X2, where X2 is the middle value of X1 and X3. Generally speaking, X2 is very close to the current price of the stock. The profit and loss of this strategy is shown in Figure 4.6.
If the stock price is kept near X2, the strategy will make a profit. If the stock price fluctuates greatly in any direction, it will cause losses (royalties). Therefore, this is a very appropriate strategy for investors who believe that the stock price is unlikely to fluctuate significantly. Comparing Figures 4.6 and 4.5, it is clear that the profit and loss status of this strategy and the saddle warrant portfolio strategy is just opposite.
Assuming X2=(X1+X3)/2, the income statement of butterfly spread warrant portfolio is as follows:
Table 4.6 Profit and loss analysis of saddle warrant portfolio (excluding initial cost) Stock price range Call warrant 1 Call warrant 2 Put warrant (short) strategy combination St X3 St-X1 St-X3 -2(St-X2) 0
On the contrary, investors can also use put warrants to construct a dished differential portfolio: buy a put warrant with a lower strike price, buy a put warrant with a higher strike price, and sell two put warrants with a middle strike price. Although the warrants composed are different, the profit and loss status of the portfolio is completely consistent with the use of warrants (Figure 4.6).
7. Summary of warrant trading strategy
Many common warrant trading strategies include a single warrant and its underlying stock. For example, when purchasing a stock and purchasing put warrants based on that stock, the hedging of assets example we mentioned earlier belongs to this kind of strategy. It is characterized by simple operation ideas, low requirements for warrant varieties and easy realization. It is mainly used to hedge assets.
The second type of warrant trading strategy mainly refers to the combination of call warrants and put warrants that hold the same stock with the same maturity date at the same time. For example, the saddle warrant combination listed above is one of them. The saddle warrant portfolio is actually a straddle warrant, because the execution prices of the call and put warrants are not completely consistent, and the bottom of the profit and loss chart is flat; If the exercise prices of the two warrants are the same, the warrant portfolio is called Straddle, and the bottom of the profit and loss chart is sharp. In addition, change the number of call or put warrants. For example, one call warrant plus two put warrants can form a Strip, and two call warrants plus one put warrant can form a Strap. There is no doubt that more interesting profit and loss states can be constructed by using the combination of warrants.
This kind of trading strategy can construct a variety of profit and loss scenarios, and has low requirements for warrant varieties, but it requires more construction costs.
The third type of trading strategy is called spread warrant trading strategy, which refers to holding (or selling) two or more warrant positions of the same type of the same underlying stock (i.e., two or more call warrants, or two or more put warrants). The butterfly spread warrant portfolio listed above is a typical representative of this strategy. Such trading strategies also include: BullSpread, which is realized by buying a warrant with a lower exercise price and selling a warrant with a higher exercise price; Bear Spread warrants, in contrast to bull spread warrants, include a long position of warrants with a higher exercise price and a short position of warrants with a lower exercise price. Another important spread warrant portfolio is the Calendar Spread, which involves warrants with the same exercise price but different expiration dates. Its construction method is to sell a warrant while buying a warrant with the same exercise price but a longer term.
Such trading strategies are more creative, but they also have many constraints. In addition to certain construction costs, they also need a variety of warrants (different execution prices, different maturity periods, etc.), and need to break through the restrictions on short selling.
In a word, one of the greatest charms of warrants is that it or its portfolio can construct a variety of profit and loss states. In fact, if the exercise price can be any value, the warrant can theoretically establish any form of profit and loss status.
| 
