Trading market declines using index put warrants
Are you looking to trade a falling market?
Index warrants provide you with an investment vehicle to trade market direction - whether bullish or bearish. They provide exposure to the broader market with minimal capital outlay and limitation of loss. Index warrants are available over several domestic and international indices such as the S&P ASX 200 and the US based S&P 500 index. If you are unsure of which stocks to trade in the market due to volatility, index put options allow you the opportunity to trade the direction of the market on a broader scale.
Currently, ASX quotes warrants issued over several leading domestic and overseas indices. A unique 3-letter code identifies each index, for example the S&P 200 is XJO.
Example - Trading the S&P ASX 200 Index (XJO)
Lets assumethat you are short-term bearish and expect the S&P ASX 200 index to fall within a one month period. Trying to maximise your return, you decide to invest $5,000 into the market through the use of an S&P ASX 200 index put warrant.
Warrant Description - Purchased an At-the-money put warrant (ASX Code: XJOTMV)
|Underlying asset||S&P ASX 200 Index|
|Warrant type||Put warrant|
The table below compares the results of investing in XJOTMV put warrants to the performance of the index.
|S&P ASX 200||Buy XJOTMV|
|Number of units||-||1915|
|Entry price/index value (3.11.2008)||4211.50||$2.61|
|Exit price/index value (27.11.2008)||3588.00||$3.98|
|Profit (per unit)||-||$1.37|
|Percentage return (%)||-15.01%||52.47%|
Conclusion - Index declines magnify put warrant returns
During the one month period the S&P ASX 200 benchmark index declined by 15.01%. The decline in the S&P ASX 200 resulted in a 52.47% return on the XJOTMV index put warrants. Index put warrants provide leveraged exposure with minimum capital outlay and limitation of losses.
If you have a bullish view, purchasing call warrants allows you the opportunity to participate from a rise in the underlying index, with limited risk.
Main benefits of the strategy
- Participate in the performance of either a domestic or an international equity market with one product
- Leveraged exposure to a fall in the index. Index warrants are one of the few ways to gain exposure to a rising or declining market
- Loss is limited to the amount invested
- You can use index put warrants to protect the value of a portfolio of shares tracking the index
Main risks of the strategy
- If the index moves unfavourably, the index warrant will reflect this in terms of leveraged losses, limited to the initial investment amount
- Time decay works against a bought put warrant
- For foreign index warrants, fluctuations in the exchange rate - AUD vs USD for example, can impact on the performance of your trade. A strengthening in the AUD will reduce the profitability of trading foreign index warrants.
Golden Rules to follow when using trading warrants
- Always have a strong directional view on the underlying stock
- Choose an exercise price that suits your view of the stock
- Keep an eye on volatility
- Plan entry and exit points when trading
- Paper trade before trying a new strategy