Hong Kong SFC Warns Investors On Warrants

by Mary Swire, Tax-News.com, Hong Kong

05 February 2008

The Hong Kong Securities and Futures Commission has warned investors they should fully understand how warrants work, and the risks involved before making investments, as these complex and risky derivative instruments are not suitable for many individual investors.

It revealed that Hong Kong's derivative warrants market has grown tremendously in recent years, largely due to increased interest by retail investors. The average daily turnover of derivative warrants in December doubled last January's figure to HKD28 billion, and their share of overall market turnover rose to 29% from 21%. The number of outstanding issues of derivative warrants also grew from 1,922 to 4,441.

Easy access to market information and the availability of marketing materials on derivative warrants also fuelled the popularity of this product among retail investors, the SFC noted.

However, the Commission went on to explain that many investors still have some common misconceptions about derivative warrants. Many mistakenly believe the price of a warrant must go up whenever the underlying price moves in their anticipated direction. But they have overlooked some key factors affecting warrant prices - most importantly, the exercise price and time to expiry.

As an example, it said that investors are often drawn to deeply out-of-the-money short-dated warrants because of a mistaken belief that they can make big gains from swings in the underlying price before expiry, without realising that these warrants are usually less sensitive to movement in the underlying price.

Many investors also mistakenly believe liquidity providers are required to support warrant prices. In practice, like other market participants, a liquidity provider is free to buy and sell at any price and at any time.

The Commission called on investors to familiarise themselves with the obligations of liquidity providers before trading in warrants.

It also warned investors that should not rely on media recommendations, as they do not take into account individual circumstances. Some recommendations are given by warrant issuers, either in their own sponsored programmes, or by appearing as guests in financial programmes, rather than by independent market practitioners. They therefore represent a particular issuer's view, and may not take all factors into account, the SFC stated.

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