An Example Of A "Cheap" Warrant

Blogger conradagosy said...

Salvatore,

And Sime CB, at 3 sen, if I buy RM30,000 worth, how much downside risk is it really? Or am I again sucked in by some fallacy?


Sime-CB Current Px MYR 8.600 Expiry 16/07/2008 Exercise MYR 12.000 (10 into 1) Pm 43.02326 At 3 sen, it seems very cheap in absolute terms. The share has 3 months to make up 3.40 in share price just to break even. Thats a staggering 39% share price increase. For the covered warrant to move beyond 5 sen, you need at least a 30% rise in Sime Darby's share price for the covered warrant to even move to 5 sen. Bear in mind that you need 10 warrant to convert, hence the real exercise price is RM12.00 plus your 10 warrants. Hence to BUY at 3 sen, you MUST be willing to see it go to zero.

First, you must believe that the share price will go to RM12.00 - if you think that, buy the share. There is no expiry and you still get 40% gain plus dividends. You won't risk losing 100% of capital invested even if the mother share was to drop a further 10% to RM7.60 even.

Is it a good bet, NO! If you like the stock or you think sentiment should somehow turn up within the expiry period, better to buy the mother share itself. The lure is very high in that if you buy at 3 sen and sell at 6 sen you will get a 100% return. That is a trap. In fact, if sentiment really jumps up, and the share jumps to RM10.50 next week, its much better mathematically to buy the covered at 5 sen then. Leave this one alone, its VERY likely to go to zero.

The value-add in this post is not whether its a buy or sell, but rather the thought-process that everyone should go through in examining the attractiveness of a covered warrant.

p/s photo: Lee Sin Je


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