How covered warrant issuers make money

Lectures on covered warrants (XXII) How covered warrant issuers make money

Ping An Securities Derivatives Department

We have mentioned the relationship between covered warrant issuers and investors in previous articles. When it comes to the relationship between issuers and investors, the first idea of most people is "gambling". They believe that the relationship between issuers and investors is just like the two sides of gambling. One side loses money and the other makes money. In fact, in the covered warrant market, there may be a win-win situation or a win-win situation or a win-win situation or a win-win situation between the issuer and the investor. The game between the two is not an absolute zero sum game. The profit sources of issuers and investors are different. Investors' profit comes from looking at the future trend of the stocks. They make directional investment and earn direction. So what does the issuer really rely on to make money? In this issue, we will make a simple analysis on this topic.

Generally speaking, if issuers are interested in participating in the covered warrant market, their method of earning profits is mainly through the management of the extension amplitude to earn the amplitude spread, while the management of the extension amplitude is mainly through the calculation of the historical amplitude of the positive shares. For example, the historical fluctuation of the positive shares is 35%. If the issuer believes that the future extension fluctuation will not exceed 35%, it will sell covered warrants with 35% extension fluctuation. If the final fluctuation is higher than expected, the issuer will lose money. Therefore, the issuer is faced with volatility risk, while the general investors are faced with directional risk of related assets. They are faced with different risks and may not have a direct relationship, so there is no relationship between winning and losing.

In fact, the best situation is that issuers earn profits through volatility management, and investors earn returns by looking at the future trend of the positive shares, so that issuers and investors can achieve a win-win situation. But how can we achieve this win-win situation? For example, if the historical volatility of the positive shares is 35%, and the issuer expects that the future extension amplitude will be low, such as 34%, the issuer will consider selling covered warrants with a 35% extension amplitude. If the amplitude trend meets the expectation, the issuer may earn a profit of an extension amplitude point between 34% and 35%; If the issuer issues warrants and the investors are optimistic about the future trend of the positive shares, they can consider buying warrants. If the future trend of the positive shares meets the expectations, it can drive the price of the warrants up and the investors can earn profits. In this case, the issuer and investors can achieve a win-win situation.

If the issuer sees the trend of the extended amplitude correctly, it will earn profits, and at the same time, it will bear the risk of seeing the direction of the amplitude wrong. For example, if the issuer expects that the future volatility will not be too high, and sells covered warrants with 35% extended volatility, but the extended volatility rises to 37%, which increases the hedging costs of the issuer, it will lose two volatility ideas. In this case, the issuer will lose money when issuing covered warrants.

In summary, issuers and investors are not gambling. The profit sources of issuers and investors are different. If investors look in the right direction, they will earn profits due to the rise of warrant price; If the issuer mismanages the extension amplitude, mistakenly thinking it is too low but actually too high, the issuer will lose money. However, the profit earned by investors may not be the same as the loss of issuers. Of course, the best case is that the issuer can see the trend of the extended volatility based on experience, thus obtaining profits, and the investors can also make full use of their knowledge and judgment in warrant investment to see the trend of the positive shares, so as to achieve a win-win situation.

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