Warrants are a popular investment product in Hong Kong. Warrants are an instrument which gives investors the right – but not the obligation – to buy or sell the underlying asset (e.g. a stock) at a pre-set price on or before a specified date.
Subscription warrant vs. covered warrant
A warrant can be issued by:
a listed company (i.e. subscription warrant)
Subscription warrants are issued by a listed company and give holders the rights to buy the underlying shares of the company. They are either attached to new shares sold in initial public offerings, or distributed together with declared dividends, bonus shares or rights issues. Subscription warrants are valid between 1 and 5 years. Upon exercise, the underlying company will issue new shares and deliver them to the warrant holders; or
a third party such as a financial institution (i.e. derivative warrant).
Derivative warrants are issued by financial institutions. Unlike subscription warrants which must be call warrants, derivative warrants can be call or put warrants. Most of the derivative warrants in the market have a shorter life, ranging from 6 months to 2 years normally, although the current Listing Rules allow a maximum life of 5 years. Derivative warrants can be linked with a single stock, a basket of stocks, an index, a currency, a commodity or a futures contract (e.g. oil futures). They can be settled by cash or physical delivery, which must be specified by the issuers at launch. However, basket 1, index warrants and warrants on stocks listed overseas are settled by cash only.
Exercising a derivative warrant
If a derivative warrant is in-the-money on the expiry day, cash-settled derivative warrants are usually automatically exercised, paying the warrant holders a positive cash settlement amount according to the terms and conditions in the listing documents.