Inline Warrants Education
What is Inline Warrant ?
Inline warrants, like standard call/put derivative warrants and CBBCs, are structured products traded on the Stock Exchange of Hong Kong Limited. Inline warrants have very different characteristics when compared with call/put derivative warrants or CBBCs and these unique features provide investors with more options and flexibility in positioning for different market conditions. The holder of an inline warrant receives at expiry, HKD 1.00 per inline warrant, if price of the underlying asset lies between the lower and upper strike; HKD 0.25 per inline warrant, if the price of the underlying asset is below the lower strike or price is above the upper strike.
What factors affect the pricing of inline warrants?
Price of underlying asset
When the price of the underlying asset lies between the upper and lower strike (In-the-range), the price of the inline warrant is greater chance to close to a fixed and capped amount. If the current price of underlying asset on the mid-way of In-the-range, the theoretical price of inline warrant will be the highest ,*vice versa.
Implied Volatility
The price of inline warrant may be affected by the implied volatility but will also depend on whether the price of underlying assets lies In-the-range or Out-of-the-range.
In-the-range: *If the implied volatility increases and the price of the underlying asset lies In-the-range, the theoretical price of the inline warrant goes down as there is greater chance for the underlying asset to trade Out-of-the-range at expiry.
Out-of-the-range: *If the implied volatility increases and the price of the underlying asset lies Out-of-the-range, the theoretical price of the inline warrant goes up as there is greater chance of the underlying asset to trade In-the-range at expiry.
Time Value
Time decay of inline warrant depends on whether the price of underlying assets lies between the upper and lower strike (In-the-range).
In-the-range: *If there is a decrease in time value (i.e. time to maturity decreases), the theoretical price of the inline warrant increases as the price of underlying asset becomes more likely to trade In-the-range at expiry.
Out-of-the-range: *If there is a decrease in time value (i.e. time to maturity decreases), the theoretical price of the inline warrant decreases as the price of underlying asset becomes less likely to trade In-the-range at expiry.
Other Factors
Apart from the above factors that affect the theoretical value of an inline warrant, market demand and supply also affects the pricing of inline warrants. If the outstanding quantity of an inline warrant is high and the liquidity providers hold relatively small amount of inline warrants, there is a greater chance the pricing of inline warrants be affected by the market’s demand and supply.
When such inline warrants face selling pressure, price of such inline warrants may be affected by market forces and deviated from its reasonable price. In addition, the price of inline warrants may be affected by the market conditions, such as market liquidity, hedging cost, bid and ask spread and volatility of hedging instruments.
* Assuming all other factors being constant
Strategies with inline warrants:
- Generate returns when market lacks volatility
- Directional play as price of underlying asset approaches upper/lower strike
- Investors can choose different upper and lower strikes of inline warrants according to their market view of the underlying asset
List of eligible underlying instruments for inline warrants
Hang Seng Index (HSI), Tencent Holdings (0700.HK), Ping An Insurance (2318.HK), China Construction Bank (0939.HK), AIA Group (1299.HK), China Mobile (0941.HK)
Expected Returns and Risks
Expected returns: HKD 1.00 less the amount invested for the inline warrant per inline warrant.
Expected loss: The amount invested for the inline warrant less HKD 0.25 per inline warrant.
Comparing Inline Warrants with standard warrants and CBBCs
| Inline Warrants | Standard Warrants | CBBCs | |
|---|---|---|---|
| Mandatory Call Event | No | No | Yes |
| Implied Volatility |
In-the-range:
Implied volatility up, price of inline warrant goes down.
Implied volatility down, price of inline warrant goes up.
Out-of-the-range:
Implied volatility up, price goes up.
Implied volatility down, price goes down.
|
Implied volatility up, price of warrant goes up.
Implied volatility down, price of warrant goes down. |
Minimal Impact |
| Time to Expiration | In-the-range:
As time elapses, price goes up.
Out-of-the-range:
As time elapses, price goes down.
|
As time elapses, both price of call or put goes down. | Minimal Impact |
| Max Risk | Invested amount– HKD 0.25 | Invested amount | Invested amount |
| Max Return | HKD 1.00 – Invested amount | Unlimited | Unlimited |
| Effective Gearing | Max at around 4 times, the closer to the strikes, the higher the effective gearing. | The further out of money, the higher the effective gearing. | The closer to the call level, the higher the effective gearing. |
| Settlement Price | Single Stock: Average closing price of last 5 trading days of the warrant.
Index: EAS price of the last trading day of the same month expiry HSI futures contract. |
Single Stock: Average closing price of last 5 trading days of the warrant.
Index: EAS price of the last trading day of the same month expiry HSI futures contract. |
Single Stock: Average closing price of last 5 trading days of the warrant.
Index: EAS price of the last trading day of the same month expiry HSI futures contract. |
In the event of any inconsistency between the Chinese and English version, the Chinese version shall prevail.