TRADE OF THE MONTH

How to make sure in­vestors don’t get the short end of the stick and end up with worth­less war­rants

Financial Mail - Investors Monthly - - Contents - Robert Laing

Novice in­vestors of­ten think it so­phis­ti­cated to say: “I’m go­ing short on that stock.” Most would be stumped if you de­manded de­tails. Some may re­cite the How to Sell Stock Short for Dum­mies fourstep pro­gramme: step one, bor­row a given num­ber of the stock from your bro­ker; step two, sell the stocks and pocket the pro­ceeds; step three, wait for the price of the given stock to fall so you can re­pur­chase them with part of the orig­i­nal pro­ceeds; step four, re­turn the bor­rowed stocks and pocket the profit.

The first snag is, good luck find­ing a bro­ker will­ing to loan you stock to short if you are a re­tail in­vestor — which is for­tu­nate con­sid­er­ing the dis­as­ter lurk­ing at step three for in­vestors with­out deep pock­ets when the price of the shorted stock rises in­stead of falls.

When bro­kers loan stock to their clients to short, it is on con­di­tion they keep enough cash in their broking ac­count to cover re­pur­chas­ing the bor­rowed shares. If the shorted stock’s price goes up in­stead of down, more cash has to be added to the ac­count to cover re­pur­chas­ing the bor­rowed shares at the now higher price.

Once a short seller runs out of re­sources to cover the ris­ing price of their shorted stock in the hope it will even­tu­ally fall as ex­pected, it’s game over — with cat­a­strophic losses.

A safer way to bet a share price will fall in the com­ing months is to se­lect from the range of war­rants that trade on the JSE.

Th­ese are avail­able via most re­tail stock­broking ac­counts, and a big ad­van­tage of short­ing by buy­ing “put” war­rants in­stead of bor­row­ing shares is your po­ten­tial loss is capped at your ini­tial in­vest­ment.

Stan­dard Bank is the main is­suer of war­rants in the lo­cal mar­ket, and a full list of the range avail­able is at its web­site www.war­rants.stan­dard­bank.co.za.

Of the 100 or so war­rants Stan­dard Bank has trad­ing on the JSE, only about a third are “puts”, mak­ing the range of com­pa­nies re­tail in­vestors can short fairly lim­ited.

For sake of il­lus­tra­tion, I have se­lected a put war­rant with code TRUSBP. Its long name is the cryp­tic “SB TRU 9500PP 40:1NOV18”.

Key in­for­ma­tion about war­rants, be­sides whether they are put or call, is their strike price and date.

In this ex­am­ple, the strike price is R95, and the strike date is Novem­ber 1 2018 for the put war­rant. The 40 trans­lates into one war­rant rep­re­sent­ing one­for­ti­eth of an op­tion re­quir­ing Stan­dard Bank to buy a Tru­worths share for R95 on Novem­ber 1 ir­re­spec­tive of what its price on the JSE is then.

What frac­tion of an op­tion the war­rant rep­re­sents is im­por­tant in valu­ing it. If Tru­worths’ share price has fallen to R80 on Novem­ber 1, the value of the R95 op­tion would be about R15, ig­nor­ing real world fric­tions like broking fees and taxes.

Since each war­rant is only one-for­ti­eth of an op­tion, their value would be about 37c each.

For the put war­rant to have any value on Novem­ber 1, Tru­worths’ share price would have to be lower than R95.

When Stan­dard Bank is­sued its TRUSBP war­rants, Tru­worths was trad­ing at about R100, at which time JSE pun­ters val­ued the war­rants at 29c.

At time of writ­ing, the put war­rant is “in the money” in that Tru­worths’ share price has fallen un­der R95 to about R83.

To keep with the cloth­ing re­tailer theme, I’ll use “SB TFG R190CA 60:1AUG18” with code TFGSBA as the ex­am­ple of go­ing long.

When th­ese were is­sued on March 14, TFG’s share price was R216.35 and the call war­rants traded at 68c, in­di­cat­ing pun­ters were ex­pect­ing it to be higher than R231 on the strike date on Au­gust 1.

TFG’s share price has sub­se­quently de­clined to below its R190 strike price to trade at about R187, and the call war­rant has fallen in tan­dem to about 19c.

A rea­son for buy­ing a call war­rant rather than a share you are op­ti­mistic about it­self is that it can am­plify your win­nings, es­pe­cially if you are a short-term in­vestor with only a few months’ hori­zon.

But if you buy the shares, at least you get to keep them if their price falls.

War­rants that have fallen to the wrong side of their strike price by the strike date, on the other hand, are worth­less.

A big ad­van­tage of short­ing by buy­ing ‘put’ war­rants in­stead of bor­row­ing shares is your po­ten­tial loss is capped at your ini­tial in­vest­ment When bro­kers loan stock to their clients to short, it is on con­di­tion they keep enough cash in their broking ac­count to cover re­pur­chas­ing the bor­rowed shares

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.