Knock-out warrants

Knock-out warrants are similar to call and put warrants except they contain a knock-out or barrier feature. Issued as either calls or puts, they allow you to trade a rising or falling share price or index. Some issuers refer to them as Turbos.

Knock-out warrants are generally issued 'in-the-money' with a delta of 1, the issue price represents the difference between the current share price or index level and the exercise price, plus a small premium.

Features

Underlying assets Issued over Shares or and Index
Term to expiry Specified by PDS
Exercise style American
Exercise price Generally the same as knock out level
Code abbreviation 6 letter code with the fourth letter being a X
Initial payment Share price - Exercise Price + Premium
Knock-out level  The warrant terminates or ceases to exist if the underlying asset touches the barrier level
Settlement Deliverable or Cash settled
Other features Issued in-the-money with a delta of 1

Knock-out warrants are highly leveraged trading tools by paying only a fraction of the value of the share or index.
Because of the high delta, the warrant price will most likely reflect the change in the underlying asset’s price, thus giving you greater leverage than the underlying share.

The time value component is relative small due to the warrant being ‘in-the money’ and containing the knock-out feature. As a result, the amount of time value that can erode over time is less than that of an otherwise identical vanilla trading warrant.

The knock-out or barrier feature can cause the warrant to expire early, without notice and value. When investing in warrants, the maximum amount at risk is your initial investment (plus transaction costs).

Upon expiry, you may be entitled to a payment of intrinsic value from the issuer. You can elect for physical settlement of the underlying shares upon exercise of the knock-out warrant.

Example of a equity knock-out warrant

Warrant code BHPXOI
Underlying asset BHP Billiton Ltd
Exercise price $28.00
Knock-out level $28.00
Warrant type Call warrant
Expiry date 23 June 2009
Conversion ratio 1

BHPXOI warrants give you the right, but not the obligation to buy BHP Billiton Ltd shares at $28.00 on the expiry date. If the share price hits $28.00 any time during the period of trading ,the warrant will terminate immediately, and expire worthless.

Example of an index knock-out warrant

Warrant code XJOXMK
Underlying asset S & P ASX 200 Index
Exercise price 3500
Knock-out level 3500
Warrant type Call warrant
Expiry date 23 June 2009
Conversion ratio 0.005

XJOWMK warrants are cash settled based on the exercise price of 3500. If the S &P ASX 200 hits 3500 any time during the period of trading ,the warrant will terminate immediately, and expire worthless.

The disclosure document outlines the terms and conditions for each warrant series. You should be familiar with those prior to trading. You can access information on how to find a disclosure document on the ASX website. Alternatively, you may contact your adviser or the warrant issuer.

Learn more about knock-out warrants. Visit our online warrants class.