Buying call warrants for leverage

Do you have a bullish view on the market or a certain stock?

Traders often use call warrants to speculate on the short-term movements of an underlying asset, with the potential benefit of leveraged returns.  With minimal upfront capital you can gain exposure to a range of assets, such as shares, currencies, and indices (eg S&P/ASX 200).

Example

You are a trader who follows the currency market. At the time the AUD is trading at US71.3c. You are bullish with the view that the AUD will appreciate over the coming week to US74.0c. To profit from this opportunity you decide to purchase a call warrant with an exercise price of US$7.00 at $0.36. 

Five days later, the AUD strengthens to US74.0c as you expected. This represents an increase of 3.8%. The call warrant is now trading at $0.57 (up from the initial price of $0.36) and you sell it, generating a 58.33% return on investment.

Currency (AUD/USD) Currency call warrant - AXUWMA
Buy price 71.3c 36c
Sell price 74c 57c
Profit 2.7c 21c
Return on investment (%)           3.8% 58.3%

In summary, the currency call warrant provided you with leveraged exposure to a strengthening AUD. The maximum amount you can lose is the money you initially invested.

You can calculate the relevant currency rate at which your investment in the call warrant becomes profitable (break-even). You need to convert the warrant price into the relevant USD amount. 

Break-even

US$ 7.00 + (A$ 0.36 * US$ 0.713) = US$ 7.257

If you held the strategy until expiry of the warrant, the pay-off diagram for the warrant position would look as follows:

Main benefits of the strategy

  • You can generate greater leverage compared to an investment in the underlying asset itself, if your view of the price is correct
  • The maximum amount at risk is what you invested in, there are no margin calls

Main risks of the strategy

  • As leverage works both ways, an unfavourable move in the underlying asset will lead to leveraged losses
  • When purchasing warrants time value decay is always a factor that you need to consider.
  • Warrants have an expiry date

 

Disclaimer
The information is for educational purposes only and does not constitute financial product advice. ASX does not represent or warrant that the information is complete or accurate. You should consider obtaining independent advice before making any financial decisions. To the extent permitted by law, no responsibility for any loss arising in any way (including by way of negligence) from anyone acting or refraining from acting as a result of this material is accepted by ASX.