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Benefits and risks

Benefits of warrants

The wide range of warrants available means they can be used to complement a number of investment and trading strategies.

Despite their differences, warrants offer some common benefits. These include the ability to use leverage, the security that you will never lose more than your initial investment and the potential for favourable tax treatment (depending on the circumstances).

Leverage

Warrants can provide you with exposure to an underlying asset for a portion of the price. As a result, a warrant gives you leverage which means small changes in the value of the underlying asset result in larger changes in the value of the warrant. This magnifies gains and losses.

For example, a 5 per cent change in the underlying share price could see the market value of a warrant increase by 20 per cent.

Tailoring

Warrant issuers have a large amount of flexibility in how they structure this type of investment, which allows a warrant series to be tailored to particular investment needs. For example, index MINIs may appeal to investors looking for exposure to moves in a particular index over a short period of time, while instalment warrants may appeal to investors looking for long-term leveraged exposure to ASX-quoted securities.

Loss limitation

The maximum amount a warrant holder can lose is the amount they paid for the warrant. The loan amount associated with the warrant is non-recourse. For example, if the value of the underlying asset ends up below the loan amount the investor can walk away from the warrant. It is this feature that allows warrants to be used as a way to leverage within a self-managed super fund.

Market exposure

Warrants enable you to cost-effectively diversify your portfolio. Index warrants, exchange-traded fund warrants and basket warrants allow you to gain exposure to movements in the wider market or in a particular sector without necessarily owning a large portfolio, whereas international index warrants and international equity warrants give you access to international markets. Other types of warrants provide direct access to commodities or currencies.

Tax benefits

Warrants may provide tax benefits for some investors. These are discussed in more detail in this report from Deloitte.

For further information download the Understanding trading and investment warrants brochure

Risks of warrants

There are certain risks involved in investing and trading in warrants. Different warrant series will have specific risks and risk profiles. You should only invest in warrants if you understand the nature of the products (specifically your rights and obligations) and the extent of your exposure to risk.

Leverage

Warrants can provide you with exposure to an underlying asset for a portion of the price. As a result, a warrant gives you leverage which means small changes in the value of the underlying asset result in larger changes in the value of the warrant.

While this can magnify your gains, it can also increase your losses. You should ensure you are comfortable with the level of leverage within any warrant you hold, and the accompanying risk.

Liquidity risk

This is the risk that you may not be able to sell your warrants for a reasonable price in the market. This could be because there are insufficient orders to buy your warrants, or the price at which others are prepared to buy them is very low. In some cases a lack of liquidity in a warrant series may be due to a lack of liquidity in the underlying instrument.

Limited life

Most warrants have a limited life, and can no longer be exercised after expiring.  Investors do not participate or benefit in any movement in the share price after expiry

If you hold a warrant until expiry and choose not to exercise it, then you may only receive a reduced payment. Alternatively, you may lose your initial stake altogether.

Early termination or expiry

In certain circumstances, a warrant may terminate or lapse before the expiry date. An example would be the triggering of barrier levels or the de-listing of underlying securities. This could result in you losing your initial investment.

Issuer risk

Each warrant is a contract between the warrant issuer and you, and there is always the risk that the issuer (or its guarantor, where relevant) will not honour its obligations under the warrant. This means you could lose your initial stake. Therefore, you must make your own assessment of the risks associated with dealing with the warrant issuer.

No National Guarantee Fund protection if you buy warrants from the issuer

In certain circumstances of broker misconduct, you may be able receive compensation from the National Guarantee Fund if you have bought or sold warrants on ASX. However, you have no recourse to the Fund if you have bought warrants directly from the issuer.

For further information download the Understanding trading and investment warrants brochure