Knock-out warrants

Knock-out warrants are similar to trading 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.

  • The warrant terminates and ceases to exist, if the relevant price of the underlying asset touches the barrier. Some knock-out warrants may pay an intrinsic value after being knocked out.
  • The disclosure document will define the price of the underlying asset that triggers the knock-out event. For example, the trigger for an index knock-out warrant could be the corresponding futures contract.
  • 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.
  • The fourth letter of the ASX warrant code for knock-out warrants is “X”.

Benefits of knock-out warrants

  • Leverage
    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.
  • Risk management
    You can use call and put warrants to manage your risk. Call warrants enable you to lock in a purchase price and defer purchasing the underlying securities to a later date. In situations where you may hold the underlying instrument, put warrants enable you to lock in a sell price for this asset, thus protecting the value of a physical share holding.

Risks of knock-out warrants

  • The underlying asset fails to perform as you expected.
  • 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).
  • Knock-out warrants offer leveraged exposure, magnifying percentage profits and losses.

Example of a knock-out warrant

Warrant code BHPXOI
Underlying asset BHP Billiton Ltd
Exercise price $13.50
Knock-out level $13.50
Warrant type Call warrant
Expiry date 23 March 2005
Conversion ratio 1

BHPXOI warrants give you the right, but not the obligation to buy BHP Billiton Ltd shares at $13.50 on the expiry date. If the share price hits $13.50 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 or view alternative educational offerings.