The sample calculations used in the following glossary/definitions are based on the following key data for shares of the fictitious CARMAKER vehicles producer.
| American option | | Warrants that may be exercised at any time prior to expiry; also known as American-style options. |
| Ask price | | The price demanded for a financial instrument. Issuers or brokers sell at this price. |
| At the money | | When the price of the underlying is equivalent or very close to the strike price. See also >out of the money, >in the money |
| Basket | | An “equity basket” comprising of several single stocks and used as the underlying of basket warrants. |
| Bid price | | The price offered for a financial instrument. On the warrants market, this is the price at which issuers or brokers offer to buy a warrant and at which investors can sell it. |
| Break-even point | | Indicates the price level above (below) which the investor will make a profit in the case of a call (put). Transaction costs are not taken into account.
Call = (warrant price / exercise ratio) + strike price
Put = strike price – (warrant price / exercise ratio) |
| Broad Lot | | is the minimum number of warrants that can be traded on the Hong Stock Exchange |
| Call warrant (call) | | Warrant granting the right to buy the underlying at the strike price according to a certain exercise ratio prior to or on the agreed expiry date, or to receive payment of a differential amount. A call warrant is often simply referred to as a call. |
| Cash settlement | | Instead of delivery of the underlying, a cash settlement may also be agreed in the terms and conditions of the warrant. If this is the case, the difference between the current price of the underlying and the strike price (adjusted for the exercise ratio) is paid out. This is standard practice. |
| Current leverage | | Leverage shows the percentage increase or decrease in the price of the warrant if the share price rises or falls by 1 percent. This, however, assumes a constant premium. See also >omega. |
| Delta | | An indicator that shows absolute changes in the price of the warrant if the price of the underlying changes. If the price of a CARMAKER share rises from HKD 43 to HKD 44, the price of the warrant will increase from HKD 0.50 to HKD 0.56. Calculation: delta (0.546) x exercise ratio (0.1) x movement in the share price. If the share price were to fall by HKD 1, the warrant would lose HKD 0.055 in value. In the case of put warrants, the delta is negative as the price of a put rises if the price of the underlying falls. With call warrants, the delta is therefore between 0 and 1; with put warrants, it is between 0 and –1. |
| Effective Gearing | | Effective Gearing – also referred to as elasticity – is regarded as “refined” leverage as it takes into account the delta. The result is often described as elasticity or gearing. The omega indicates the percentage change in the price of the warrant relative to a one percent change in the share price.
Omega = leverage x delta
Example: 8.6 x 0.546 = 4.7%
If, therefore, the share price rises by 1 percent from SGD 43 to SGD 43.43, the warrant price will increase by 4.7% to SGD 0.5235. |
| European option | | Warrants that may only be exercised on the expiry date; also known as European-style options. |
| Exercise | | Use of the right granted by the option. This typically requires written notice of intent. However, in Hong Kong, all European style cash settled warrants are subject to automatic exercise if they are in-the-money at maturity. Warrantholders will not be required to deliver any exercise notice. |
| Exercise ratio | | Indicates the number of options per warrant and specifies the amount of the underlying that the owner of a single warrant is entitled to buy or sell. |
| Expected volatility | | The expected price fluctuation range of a warrant’s underlying within a specified future time period, which usually corresponds to the option's time to maturity. |
| Gamma | | Indicator that shows changes in the delta following price movements of the underlying.
If the CARMAKER share price moves by a currency unit, the delta also moves. A Gamma of 0.03 (Gamma x exercise ratio) means the delta of the call will increase from 0.546 to 0.576 if the share price rises to SGD 44. If the share price falls to SGD 42, the delta will fall to 0.516. It is important to note that, in the case of put warrants, the delta increases if the price of the underlying decreases and the delta falls if the price of the underlying rises. |
| Hedging | | Limits the risk involved in a securities transaction by means of a second countertransaction. For example, put warrants may be used as a hedge to insure against price losses in a securities portfolio. |
| Historical volatility | | Price fluctuation range of a warrant's underlying during a specified period in the past. |
| Implied volatility | | Volatility as determined on the basis of prices of options and warrants traded at a particular time on the market. |
| In the money | | Describes the situation when a warrant has an intrinsic value i.e. in the case of calls, the current price of the underlying is above, and in the case of puts, below the strike price. See also >at the money, >out of the money |
| Intrinsic value | | The actual value of an option when exercised at a particular point in time – also known as parity. This equals the (positive) difference between the strike price and the current price of the underlying, taking into account the exercise ratio.
Intrinsic value of call = (price of the underlying – strike price) x exercise ratio
Example: (SGD 43 – SGD 45) x 0.1 = SGD 0*
Intrinsic value of put = (strike price – price of the underlying) x exercise ratio
Example: (SGD 45 – SGD 43) x 0.1 = SGD 0.2
*Note: the intrinsic value of an option can never be negative. |
| Issuer | | Institution that issues the warrant and serves as obligor for the option it represents |
| Leverage | | Leverage shows the extent to which a warrant moves in line with its underlying. The current leverage of a warrant is calculated by dividing the price of the underlying by the price of the warrant (adjusted for the exercise ratio). >current leverage, >omega.
Leverage = (price of the underlying / warrant price) * exercise ratio
Example: (SGD 43 / SGD 0.50) * 0.1 |
| Long call | | The purchase of a call warrant in order to speculate on a rise in the price of the underlying. |
| Long put | | The purchase of a put warrant in order to speculate on a fall in the price of the underlying. |
| Liquidity Provider | | Issuers are required to appoint Liquidity Providers (LPs) for their warrants listed on the Stock Exchange. The Stock Exchange will permit LPs to fulfil their obligation to provide liquidity by means of continuous quotes or quote request, with the chosen method stated in the listing document. Under continuous quotes, bids and offers for an issue will be posted continuously to the stock exchange. The bids and offers should be for a minimum of ten board lots of the derivative warrant issue. Under the quote request system, a telephone number that investors can call for a price will be displayed on the warrant's stock page. When an LP receives a quote request it will be expected to respond by entering a buy and sell order for a minimum of ten board lots of the derivative warrant [to the stock exchange]/[on to the warrant's stock page]. |
| Maturity | | The “lifetime” of a warrant as determined in the terms and conditions. The option expires upon maturity.Value of a derivatives warrant with underlying securities listed on the Hong Kong Stock Exchange is based on the average of the closing prices of the underlying securities (as published in the Daily Quotation Sheet of the Exchange, subject to any adjustments as may be necessary) for the five trading days up to and including the trading day before the expiry day. For derivative warrants issued over securities not listed on the Stock Exchange or assets other than equity securities, the valuation will be in accordance with the formula stated in the listing document. |
| Out of the money | | Describes the situation when a warrant has no intrinsic value i.e. in the case of calls, the current price of the underlying is below, and in the case of puts, above the strike price. See also >at the money, >in the money |
| Parity | | Synonym for the >intrinsic value of a warrant. |
| Parity-related indicators | | Generic term for warrant indicators that are based on the intrinsic value (e.g. break-even point, premium). |
| Physical delivery | | If stipulated in the option's terms and conditions, the call owner's portfolio is credited with the underlying at the agreed strike price upon exercising the option. The owner of a put is entitled to sell the underlying in line with the agreed terms and conditions. A cash settlement may be agreed instead of physical delivery. |
| Premium | | The amount by which the cost of acquiring the underlying by exercising the warrant exceeds the cost of buying the underlying directly. |
| Premium (annual) | | The time to maturity of the warrant also affects the premium level. Premiums are therefore compared on an annual basis. |
| Put warrant (put) | | Warrant granting the right to sell the underlying at the strike price according to a certain exercise ratio prior to or on the agreed expiry date. It may also entitle the owner to receive payment of an appropriate differential amount. A put warrant is often simply referred to as a put. |
| Rho | | Indicator which shows the influence of changes in general interest-rate levels on the price of warrants. |
| Spread | | The difference between the bid and ask prices. The spread can be specified as a percentage or in currency units. Note: in order to compare the spreads of warrants, they must be homogenised i.e. they must be based on the same exercise ratio. |
| Straddle | | Simultaneous purchase of calls and puts on the same underlying as well as identical strike prices and maturities. The aim is to benefit from sudden price changes and/or an increase in volatility. |
| Strike price | | The price at which the financial instrument underlying the option may be bought (calls) or sold (puts) as well as the price which is used to calculate the cash settlement, where applicable. |
| Theta | | Indicator which shows the influence of time on the price of warrants. It indicates the extent to which the warrant price changes on a daily basis as the time to maturity decreases. If, in the space of a week (i.e. 7 days, not 5 working days), the warrant loses 1.12 percent or SGD 0.006 in value, its price will fall from SGD 0.50 to SGD 0.49. |
| Time value | | The time value is the difference between the current warrant price and its intrinsic value. The time value is to be interpreted as the consideration paid for the advantages (leverage effect) that the warrant buyer has over the direct investor. It is based on the liquidity advantage as the warrant buyer has to pay less than the buyer of the underlying.
Time value = price of the warrant – the warrant's intrinsic value
Example for a call warrant: SGD 0.50 – SGD 0 = SGD 0.50*
* The price of the call in the example comprises only time value.
Example for a put warrant: SGD 0.50 – SGD 0.20 = SGD 0.30
The chart shows the erosion of time value as we approach maturity in case
the warrant has no intrinsic value.
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Underlying
(underlying asset) | | The financial instrument underlying the warrant e.g. a share or share index. Often also referred to as the underlying asset. |
| Vega | | Indicator which shows how sensitive warrant prices are to changes in volatility. The price of the warrant includes an implied volatility of 30.5 percent. If the implied volatility increases by 1 percent to 31.5 percent, the warrant will gain SGD 0.02 in value (Vega x exercise ratio) and will increase to SGD 0.52. Similarly, the warrant will lose SGD 0.02 if the implied volatility falls by one percentage point. |
| Volatility | | Volatility measures the fluctuation range of the underlying's price within a specified time period e.g. a year. See also >historical volatility, >implied volatility. |
| Warrant |  | International common naming for securitised options. |
