What are warrants? Well, they are a type of geared investment. Gearing describes the process of increasing your exposure to a certain investment for the same outlay.
Companies become highly geared if they use a large proportion of borrowed money in addition to share capital to fund their operations. Gearing up is a very risky strategy - just as you can magnify your gains, so losses are exaggerated too.
Warrants are securities which give you the right to buy a certain share at a certain price (the exercise or subscription price) before a fixed time in the future.
They can be traded and usually cost only a fraction of the price of the share itself. Often, the exercise price is not far off the share's current price. If this is the case, warrant holders benefit from any rise in that share's price just as they would have done by owning the share, but for a fraction of the cost.
On the market, the price of a particular warrant fluctuates, often exaggerating the underlying share's movements. You can either make money by selling the warrants after a big rise, or by waiting until the warrants can be exercised and then buying the shares that they represent. You then make an instant profit by selling that share at the - hopefully - higher market price.
There is a downside: these are very risky investments indeed. If the share price falls below the strike price, or never even reaches it, then your warrant is worthless. You could lose all the capital you invested.
In effect, when you buy warrants you are betting on future price movements, so you should only invest money you can afford to lose. But there are huge potential gains to be made if you are both daring and well-informed.
One person who has done well is Kean Seager, the chairman at Whitechurch Securities. He says: "I don't simply look for the most risky investment. I start by making normal decisions first. This means looking for the right sector and where prospects look promising."
For example in February 1997, Mr Seager felt the UK equity market was likely to do well. If UK equities were likely to do well, he felt capital shares in split capital investment trusts would do better. Taking the logic of his argument further, he opted for warrants in the capital shares themselves - gearing up on a geared investment.
Mr Seager bought 25,000 warrants in Fleming Income & Growth at 6p each. As of mid-anuary this year, they were worth 83.5 pence, up 14 times on their original price in under two years. Companies issue warrants as a way of raising finance. But nowadays only smaller companies issue them, which means many warrants on single company shares are particularly risky. British Aerospace is the only blue chip company which has warrants in issue at the moment.
But many investment trusts also issue warrants. "These are quite good for people to cut their teeth on because the risk is slightly lower," says Andrew McHattie, editor of specialist newsletter Warrants Alert. About 130 of the 190 warrants listed on the London Stock Exchange are investment trust warrants, he adds.
You buy warrants through a stockbroker or financial adviser. The cost is the same as dealing in shares; when you come to exercise the warrant there is no fee to pay. But novices to warrants should expect a wariness from stockbrokers. "Most brokers won't let you near warrants until you've signed a risk warning notice," says Matthew Orr of stockbrokers Killik & Co.
How do you choose a warrant? Tim Cockerill, of independent advisers Whitechurch Securities in Bristol, advises looking for warrants with a long life. "Anyone who's dabbling in warrants, especially for the first time, should get one with a long life - it's like a safety net," he says.
Perpetual Income & Growth warrants have 7.8 years left to run. "So if everything goes disastrously wrong in the next two years, you still have time for it to recover," Mr Cockerill says. The warrants cost 37p and the subscription price is pounds 1. Shares in the trust are currently trading at pounds 1.27.
For a more exciting time, Mr Cockerill recommends Foreign & Colonial Latin American warrants which have 6.3 years left to run. The warrants cost 42p and have a subscription price of 62p. With the shares trading at 89p, this means the warrants are now at a premium of 15p - wider than that of the Perpetual warrants.
Other investment trust warrants worth watching are Henderson Technology Trust warrants and TR European Growth Trust warrants, says Andrew McHattie. The Henderson warrants provide exposure to the rapidly expanding technology sector while holders of the TR warrants stand to gain from a recovery in the trust's portfolio.
Should you wait to exercise your warrants, or sell them? If you have managed to double your money in a short time, then this could be a good time to sell them, says Mr Cockerill. "You have to ask yourself what you are going into warrants for," he says. "If it is for a short-term gain, then if you see it, take it." But if you aim for longer term gains, it may be worth waiting to actually exercise the warrant.
Whatever happens, don't forget to exercise them. Warrants have an expiry date, and if this passes before you have exercised them, they automatically become worthless.
This situation has sparked rows between client and broker. "Make it clear who has responsibility for monitoring the warrant," says Mr Orr.
Warrants are widely seen as a dying market in the UK. "A lot of them tended to be issued on Far East trusts, and they fell out of bed," says Gideon Foster of brokers Wise Speke. Although few major companies now issue warrants, there is a huge market in Europe for covered warrants, which are linked to more estab- lished shares but are issued by third parties.
However, covered warrants cannot be traded on the London Stock Exchange, and the dealing costs are usually too high for smaller investors.
In some senses, warrants can be a way of making your money work twice, says Matthew Orr. Because warrants cost a fraction of a share price, the remaining cash can accrue interest in a bank or building society account. But holders of warrants do not get the dividends shareholders do. "If that share is a big dividend payer, then you've got to factor that in," Mr Orr says.
And although you do risk losing all your money when you buy warrants, there is a more positive way of looking at it. This is the only money you stand to lose. "If you'd bought the security, you could, in theory, watch the thing go bust," says Mr Orr.
Warrants Alert: 0117 9258882; Whitechurch Securities: 0117 9442266; Killik & Co: 0171-761 4400
`The Independent' is offering a free `Guide to High Risk/High Reward Investment', which outlines the most common ways in which savers can obtain higher than average returns on their funds, including warrants, by taking a more aggressive approach with their money. Your free copy of the guide, which is sponsored by Whitechurch Securities, is available by calling 0845 2711003