Warrants are a type of derivative issued by a small number of financial instructions. They are traded on the ASX or Chi-X, and settlement occurs through CHESS.
Warrants derive their value from an underlying instrument, including:
> a basket of securities
> Exchange Traded Funds (ETFs)
> a share price index
> debt instruments
Warrants give holders the right to buy or sell the underlying instrument to the warrant issuer for a specific price, according to the terms of issue. Warrants are generally categorised as either a trading warrant or investment warrant, although some have characteristics of both.
The following table summarises the key differences between the two:
|Investment warrants||Trading warrants|
|Why are they used?||Borrow to invest in shares and increase exposure to potential capital growth, dividends and franking credits||Trade the rise or fall shares, indices, commodities and currencies|
|Features||Longer dated and less frequently traded, lower risk/return profile and tend to have a higher initial outlay required||Frequently traded and shorter dates, higher risk/return profile|
|Investment timeframe||Medium to long term||Short term|
|Key Benefits||Leverage and no margin calls||Leverage and no margin calls|
|Key investment risks||Leverage can magnify losses||Leverage can magnify losses|
|Used by||SMSFs and individual investors||SMSFs and individual investors|
|Examples||Endowments and structured investment products||Equity warrants, index warrants, barrier warrants and MINI warrants|
An instalment warrant gives the investor the right to buy the underlying asset with an initial part payment and an optional final payment. Key features of instalment warrants include:
> The investor is entitled to all dividends, distributions and franking credits
> Generally offered over ASX100 securities
> They are an eligible form of gearing for SMSFs.
A MINI warrant is also available as either a trading or investment warrant.
It’s important to note that warrants don’t have standardised terms, although they are limited by the constraints of the ASX Operating Rules and the law.