Money: Warranting closer attention

Nic Cicutti on how higher risks can pay

Equity investment is, at its most basic, a sophisticated gamble. It offers the potential to make vast amounts of money, as long as the investor is prepared to accept the possibility of losing it all.

Few investments carry more of a risk warning than warrants, which are available on the shares of trading companies and of investment trusts. More than pounds 600m is invested in a range of more than 150 warrants on offer from investment trusts alone.

A "warrant" is the option to buy a share at a future price, fixed at the outset and called the "exercise price".

The option may be taken up either on a particular date or a set of dates. This can take place each year up to a final date, after which the option lapses.

An investor makes a profit if the exercise price of the share at the relevant date, plus the cost of the warrant itself at the time it was first bought, jointly add up to less than the current market value of the share.

If the exercise price is higher than the existing market price of the share, the warrant does not have to be bought. However, if every exercise date is passed on without the exercise price being paid, the warrant lapses, leaving the investor out of pocket.

The aim is to choose a warrant that is cheap when it is first bought, with a low exercise price. Warrants are traded on the Stock Exchange and because they are bought as investments in their own right, they can vary in price over time.

Prices of warrants are lower than those of the shares they are linked with, but they do reflect the underlying share price. In effect, investors can achieve the same exposure to a share, and its potential upside, for a fraction of the price.

If, say, a share is priced at 200p and rises to 250p, investors are sitting on a 25 per cent gain. If the warrant was priced at 50p, that same rise in the share's value might translate into a 100 per cent gain. Equally, there is far more of a risk element. The same fall in the value of a share will impact far more on a warrant.

Investment experts call this phenomenon "gearing", which is measured as the share price divided by the warrant price. Therefore, high gearing means high risk.

Warrant prices are also affected by extra considerations. These include the lifespan of the investment itself up to the final exercise date. The longer the remaining lifespan of a warrant, the more it will cost to buy because there will probably be several exercise dates - with the potential to generate a profit for the investor - before it lapses.

Another factor affecting potential profits is the "premium" at which a warrant is sold - this is the difference between the exercise price plus the cost of the warrant itself, compared to the current price of the underlying share. The higher the premium, the higher the element of risk may be.

One major area of choice for would-be warrant investors lies in investment trusts, where they have generated an average return of 21.55 per cent, against a 9.58 per cent average rise in investment trust share prices and gains of 9.46 per cent from the FTSE All Share index and 13.94 per cent from the MSCI World index.

However, warrant prices remain depressed, partly due to continuing worries over the outlook for the market.

Williams de Broe, the stockbroking firm, points out that for investors worried about the potential of a downswing in UK stocks many investment trusts show a strong bias towards international markets and smaller company sectors, with emerging markets taking up pounds 160m of the pounds 600m market and European sector warrants a further pounds 102m.

Many investment trusts now carry no premium, in some cases even a discount to their underlying share price, making it unprofitable to exercise the right to buy. Equally, investors can buy "geared" exposure at less than the value of the underlying investment trust's assets.

Clearly, there are opportunities for canny speculators, although any choices need to be carefully made. For most savers, this will not be an area in which they will want to risk their shirt.

However, for those with the majority of their assets in unit and investment trusts, who have also invested in far safer Tessas and similar funds, a small warrant punt is an option.

As in all such cases talking to a good investment adviser is critical. The wrong decision could mean losing a lot more than with traditional investments. Getting things right, on the other hand, could leave you quids in.

Start your day with The Independent, sign up for daily news emails
PROMOTED VIDEO
Have you tried new the Independent Digital Edition apps?
Finacial products from our partners
Property search

Simon Read: Frozen in time - the expat British pensioners who deserve a better deal

I had dinner with the pensions minister Steve Webb this week. There was a wide-ranging discussion about the new pensions freedoms starting in April, and changes to the state pension. Crucially, I also got to ask Mr Webb whether he had any plans to have another look at the injustice that is frozen pensions.

Number of serially under-performing investment funds has increased by a fifth, survey reveals

The new Spot the Dog survey shows that even famous fund managers, holding billions of pounds of our money, can make mistakes

Mark Dampier: We always bring down Britain. But there's plenty in the tank

While the health of the economy is not insignificant, Mark Dampier finds it incredibly unpredictable in terms of its impact on the stock market

If you haven’t switched supplier or tariff in the last 12 months then you could almost certainly save money by doing so

There are easier ways to save hundreds on your energy bills

A new free app is aimed at the three-fifths of Brits who have never switched supplier

Worse hit are loyal customers with long-standing accounts – their loyalty is rewarded with lower interest rates than more recently-launched accounts

Savers are being let down by banks and building societies, says Financial Conduct Authority

Regulator’s investigation into the market found that around £160bn was held in easy access savings accounts that pay interest lower or equal to BoE base rate

What to do if you're facing repossession: However far you fall, you're not on your own

Helen Fisher had to become a 24-hour carer, and then she faced repossession. But going to the right places for help changed everything, writes Simon Read

Simon Read: Information is power. And it's in the wrong hands when people are cold-called by companies that know they're in debt

In debt? You're likely to be targeted by unscrupulous companies that hope to profit from your misfortune. They may try to pretend to be your friend by offering what they call "help" – but almost certainly that help will come with a cost and leave you worse off than you were before they got in touch.

Mark Dampier: So you've got pension freedom... will it end up as a cold shower?

In less than three months' time radical changes to pensions will take effect, providing investors with more freedom. Yet for those who prefer to make their own investment decisions, the choice of funds available is overwhelming. And an income drawdown account is also not particularly easy to manage.

The move marks the culmination of a long campaign by debt charities and insolvency firms and follows a call for evidence launched by the Minister last August

Bankruptcy rules to change, Business Minister announces

The minimum amount for which you can be forced into bankruptcy is being raised from £750 to £5,000

Three-quarters of parents say being unable to afford to heat their home adequately is hitting the health of their children

Family well-being and health hit by heating costs

A shock report reveals that fuel poverty is affecting desperate families – and their children

Many people have no understanding of pensions

Are you ready for pensions reforms?

Most people are too confused to know how to use their pensions for a secure income

At a rate of 7.5 per cent, the wind is blowing behind ethical investors

A new initiative has financial and ethical virtues, says Simon Read
Ticket to cry: many passengers have been penalised with exorbitant and unnecessary rises

Simon Read: Inflation is riding the slow train. So why have we been given a one-way ticket to travel on the fares express?

I struck a chord with many of you when I wrote a piece earlier this week about rising train fares. It seems there is an army of travellers who feel they've been ripped off by increased transport costs.

Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Recruitment Genius: Compliance Assistant

    £13000 per annum: Recruitment Genius: This Pension Specialist was established ...

    Ashdown Group: Market Research Executive

    £23000 - £26000 per annum + Benefits: Ashdown Group: Market Research Executive...

    Recruitment Genius: Technical Report Writer

    £25000 - £35000 per annum: Recruitment Genius: A Technical Report Writer is re...

    MBDA UK Ltd: Indirect Procurement Category Manager

    Competitive salary & benefits!: MBDA UK Ltd: MBDA UK LTD Indirect Procurement...

    Day In a Page

    Isis hostage crisis: The prisoner swap has only one purpose for the militants - recognition its Islamic State exists and that foreign nations acknowledge its power

    Isis hostage crisis

    The prisoner swap has only one purpose for the militants - recognition its Islamic State exists and that foreign nations acknowledge its power, says Robert Fisk
    Homeless Veterans appeal: ‘If you’re hard on the world you are hard on yourself’

    Homeless Veterans appeal: ‘If you’re hard on the world you are hard on yourself’

    Maverick artist Grayson Perry backs our campaign
    Missing salvage expert who found $50m of sunken treasure before disappearing, tracked down at last

    The runaway buccaneers and the ship full of gold

    Salvage expert Tommy Thompson found sunken treasure worth millions. Then he vanished... until now
    Assisted Dying Bill: I want to be able to decide about my own death - I want to have control of my life

    Assisted Dying Bill: 'I want control of my life'

    This week the Assisted Dying Bill is debated in the Lords. Virginia Ironside, who has already made plans for her own self-deliverance, argues that it's time we allowed people a humane, compassionate death
    11 best winter skin treats

    Give your moisturiser a helping hand: 11 best winter skin treats

    Get an extra boost of nourishment from one of these hard-working products
    Isis hostage crisis: Militant group stands strong as its numerous enemies fail to find a common plan to defeat it

    Isis stands strong as its numerous enemies fail to find a common plan to defeat it

    The jihadis are being squeezed militarily and economically, but there is no sign of an implosion, says Patrick Cockburn
    Virtual reality thrusts viewers into the frontline of global events - and puts film-goers at the heart of the action

    Virtual reality: Seeing is believing

    Virtual reality thrusts viewers into the frontline of global events - and puts film-goers at the heart of the action
    Homeless Veterans appeal: MP says Coalition ‘not doing enough’

    Homeless Veterans appeal

    MP says Coalition ‘not doing enough’ to help
    Larry David, Steve Coogan and other comedians share stories of depression in new documentary

    Comedians share stories of depression

    The director of the new documentary, Kevin Pollak, tells Jessica Barrett how he got them to talk
    Has The Archers lost the plot with it's spicy storylines?

    Has The Archers lost the plot?

    A growing number of listeners are voicing their discontent over the rural soap's spicy storylines; so loudly that even the BBC's director-general seems worried, says Simon Kelner
    English Heritage adds 14 post-war office buildings to its protected lists

    14 office buildings added to protected lists

    Christopher Beanland explores the underrated appeal of these palaces of pen-pushing
    Human skull discovery in Israel proves humans lived side-by-side with Neanderthals

    Human skull discovery in Israel proves humans lived side-by-side with Neanderthals

    Scientists unearthed the cranial fragments from Manot Cave in West Galilee
    World War Z author Max Brooks honours WW1's Harlem Hellfighters in new graphic novel

    Max Brooks honours Harlem Hellfighters

    The author talks about race, legacy and his Will Smith film option to Tim Walker
    Why the league system no longer measures up

    League system no longer measures up

    Jon Coles, former head of standards at the Department of Education, used to be in charge of school performance rankings. He explains how he would reform the system
    Valentine's Day cards: 5 best online card shops

    Don't leave it to the petrol station: The best online card shops for Valentine's Day

    Can't find a card you like on the high street? Try one of these sites for individual, personalised options, whatever your taste