Buying equity puts for leverage

Are you looking to profit from a falling market?

Given the recent market activity, traders are increasingly looking to trade a falling market through put warrants.  As short selling can be rather cumbersome for traders when trading relatively small volumes, put warrants provide you with an investment vehicle that can profit from a falling market.  This is without the risk that if the market moves against you, you will not be subject to margin calls.  Put warrants allow you to achieve a leveraged exposure to a falling market with minimal capital outlay and limited risk. 

Example

Let's assume that you are bearish on BHP and have the view that the share price will fall over the next few days.  You compare the returns of buying $2,000 of the following BHP put warrant to short selling BHP shares.

Warrant code BHPWOV
Warrant price $0.10 (26.04.05)    
Underlying asset                  BHP FPO
Warrant type Put warrant
Exercise price $16.50
Expiry date 26.05.05
Conversion ratio 4

 

 

 

 

 

 

The table below compares the results of investing in the put warrant to short selling BHP shares.

Short BHP shares      Buy BHPWOV    
Capital outlay/exposure      $2,000 $2,000
Number of units 118 20,000
Entry price (26.04.05) $16.92 $0.10
Exit price (29.04.05) $16.03 $0.185
Profit (per unit) $0.89 $0.085
Total profit $105.02 $1,700

With BHP's share price falling over 5%, purchasing BHP put warrants allowed you to generate a greater profit compared to short selling BHP shares, achieving an 85% return on your investment.  This highlights the efficiency in using put warrants to trade a falling market as opposed to short selling shares.  You can replicate your view through put warrants without the risk of receiving market calls and the brokerage costs will not take a significant slice out of the profit you have made.

Related strategies

Main benefits of the strategy

  • Leveraged exposure to a fall in an underlying share. Put warrants are one of the few ways to gain exposure to a declining market
  • Loss is limited to the amount invested

Main risks of the strategy

  • If the share price moves unfavourably, the put warrant will reflect this in terms of leveraged losses, limited to the initial investment amount 
  • Time decay works against a bought put warrant

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.