One common mistake new traders make when deciding to buy a cash-settled call business warrants is over the concept of ‘break-even’. Just what is break-even?
For many novice warrant traders, break-even means the sum of what they paid for the business warrants plus the conversion/ strike price.
To these traders, they feel that in order for their trade to make a profit, there must be a good chance that the price of the underlying or mother share exceeds this break-even point.
While this may make sense in the case of physically-settled warrants (ie, warrants that convert into shares of a company), which is usually the case for company-issued warrants, it does not really mean anything when it comes to cash-settled warrants.
For cash-settled warrants, just like stocks and shares, your break-even price is the price you paid. Simple as that!
For example, if you had purchased a call business warrants today and paid 30 cent for it and sold it the next day at 40 cent, your break-even would have been 30 cent and your gain 10 cent.
Therefore, one should not be too concerned with the conversion price of call warrants. Instead, a trader should be more interested in the theoretical price of these warrants and most important of all, the direction the mother share would be taking in the short-term.
As warrants are short-term trading instruments, traders should get over this “break-even” myth right from the very beginning. Otherwise, trading in business warrants could become a costly misadventure.
The perfect time to buy a warrant is when the underlying asset is about to make a sharp gain (for a call warrant) within a short time frame. At this point of time, the gearing effect of a warrant comes into full play.
In addition, there are business warrants with different maturity periods and exercise prices to match your expectations. If you expect the market to experience a big swing, choose a warrant with a shorter time to maturity and far out-of-the-money, as this will give you a good leverage effect.
You should also study a warrant’s historical volatility (a measure of price fluctuation of the underlying asset over time) and implied volatility (market expectation on the future price fluctuation of the underlying asset) for a buy signal. For example, if you expect an upward trend in the historical volatility of the underlying, this could be a buy signal for a call business warrants.