What is the difference between an option and a Covered Warrant?

On April 28th, I was invited by Citigroup to the conference “Optimize your turbo trading with technical analysis”. I also had the pleasure of meeting some of you…

During this conference, I explained why I chose to use turbos rather than other derivatives such as warrants or options. I would like to come back to this subject today to give you an update on the difference between these products.

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First of all, to be very clear, all the products we are talking about are so-called optional products, that is, based on the calculation of a call or put option. These products multiply the variations of an underlying: raw material, stock, index, currency. Whether it’s up or down, you benefit from Leverage on the evolution of your support (the underlying). Thus, with a leverage of seven, you multiply the changes in your share or index by seven (this is the average leverage I use in my service: not too risky, but performing).

Theoretically, it’s the same with a warrant or option, these products belonging to the same family. But concretely, these products treat each other and approach each other differently… For me (and I will come back to it), it is more interesting to use the turbos, because they reflect the variations of the underlying way much more accurately. Turbos are, in use, the easiest product to trade for swing trading and taking advantage of short-term market trends, over a few days to weeks.

Read also : How to lift a purchase option?

▪ Let’s compare turbos and warrants

To compare these two products, let’s take a turbo call CAC 40 of 3,500 points barrier and a warrant call CAC 40 3,900 points due September. (When I gave this example, at my conference we were in April and the CCA was 3,900 points.) At the beginning of the operation, these two products had a leverage effect close to 9 and both bet on an increase in the ACC 40.

Fifteen days later, the CAC 40 increased from 3,900 to 4,000 points. Turbo call rose from 3.08 euros to 4.06 euros; an increase of 32%. The warrant, meanwhile, rose from 1.58 euros to 2.04 euros; or 29% increase. How to explain such a difference?

Quite simply because the warrant is penalized by so-called “time value” and “volatility”. If I had taken a later maturity on the warrant (May, June or other maturity), the difference would still be more important, and it would be exactly the same with the options.

So if we save the risk associated with the deactivating barrier (in my example, if a relapse of the CAC 40 on the 3,500 points had occurred, the turbo would have been disabled and you would have lost everything), the turbos are more interesting. The time value does not exist on a turbo. The erosion of time is such that if the CAC does not move for example for three weeks, you will not lose anything on your turbo, but you will be in relatively significant loss on your warrant or option…

Which is particularly raging since you shouldn’t be a loser if your underlying has not changed relative to your entry price! But these products are structured as well.

▪ To summarize

— A lower price;

— Potentially greater leverage;

— A slightly higher risk;

— A delta close to 100% (0 to 100 for the warrant or option), i.e. a CAC point represents a penny on the turbo for example, which makes it very simple to understand and calculate the product;

— The impact of time and volatility is almost zero.

The latter feature, as you will understand, is the most important feature for a trader: you can focus on analyzing the underlying and your starting scenario, without worrying about how time passes on your product. Less stress so.

▪ Do not get handicapped for nothing!

When volatility is low, like in recent months, the impact can be even more devastating for your product which then melts as grief skin.

Because of these two drawbacks, I have already seen a warrant call on the CAC drop while the underlying had taken more than 3%. You’ll never have this case on the turbos. This does not take away the difficulty of trading and the need to use technical analysis to best manage your positions, of course.

In a market like the one we have known for two years where no trend is clearly emerging, it is already difficult to take opportunities on the market so do not leave with a handicap!

And if you don’t feel seasoned enough to choose and trade turbos alone, feel free to try my service, Lever 7, for a month!

First publication in the Trader’s Ticket of 24/05/2011.

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