A Guide to Covered Warrants

What You Need to Know

Covered warrants are tradable financial products that allow you to invest in a particular asset- such as a share, index or commodity type- at a fraction of that asset’s full price.
Before you invest any money, it’s a good idea to have a sound understanding of the differences between the two types of covered warrant, namely ‘call warrants’ and ‘put warrants’.
Call Warrants work by allowing your to purchase an asset for a premium – this is represented by the ‘ask’ price – for a fixed period. If at the end of this period the asset price had risen above a fixed level – also known as the ‘strike’ price – then you will get a cash payout in line with your investment.
If, however, the asset price has fallen over the period, you will lose your entire initial investment, though no more.
Put Warrants work in much the same way, though they will generate a cash payout only if the asset price falls below the strike price during the designated period.
One major advantage of covered warrants is that they are leveraged. So, you are able to enjoy full exposure to the underlying asset of your choice at a fraction of the price it would cost you to buy the asset directly.
Given the entirety of your investment could be lost, covered warrants are regarded as high-risk investments. As such, they suit experienced traders and those with money they can afford to lose.

What is a Covered Warrant?

Covered warrants are tradable financial products that allow you to invest in a particular asset – for example, a share, index or commodity type - at a fraction of that asset’s full price. That is, a warrant gives you the right to buy or sell an asset at a fixed price on, or even before, a fixed future date.

This type of investment enables you to take a position on either a rise of fall of an asset type, potentially generating a cash payout at the end of a designated period, although, if the market goes the wrong way, this can lead to the loss of the initial stake.

How They Work

Quite simply, a covered warrant gives you the right, but not the obligation, to buy (or ‘call’) or to sell (to ‘put’) an asset at a specified price by a specified date. Before you invest any money, it’s a good idea to have a sound understanding of the differences between the two types of covered warrant.

Call Warrants

Call Warrants enable you to benefit from a rising market. They work by allowing you to purchase an asset for a premium – this is represented by the ‘ask’ price – for a fixed period, which is usually three, six or even 12 months. If at the end of this period the asset price had risen above a fixed level – also known as the ‘strike’ price – then you will get a cash payout in line with your investment.

If, however, the asset price has fallen over the period, you will lose your entire initial investment, though no more.

Put Warrants

Put Warrants work in much the same way, allowing you to invest in an asset for a fixed period of time. However, in this case, they will generate a cash payout only if the asset price falls below the strike price during the designated period.

Some traders like to hedge their investments by putting money into both call and put warrants, thereby ensuring they are able to generate some profit regardless of which way the market moves.

In both cases, you have the right to trade in or out of a position at any point in the trading day, with any funds owed usually deposited automatically into your personal share dealing account.

Potential Benefits of Covered Warrants

Covered warrants are a popular investment choice for many, particularly among smaller investors with relatively little capital. This is due to the fact covered warrants offer a number of benefits;

Since covered warrants are leveraged, you are able to enjoy full exposure to the underlying asset of your choice at a fraction of the price it would cost you to buy the asset directly.
Covered warrants offer a flexible alternative to investors keen to enjoy the leverage benefits of derivatives, but without the high risks.
This type of investment allows you to enjoy exposure to a range of assets, including commodities, shares and currencies, without your having to actually buy the underlying product.
Covered warrants offer high levels of liquidity. They can be bought and sold with ease and they are all cash-settled – that is, any profits are transferred to you directly without you having to trade anything.
Covered warrants are also highly transparent. Quite simply, what you see is what you get. Moreover, they are quoted throughout the trading day and are easily bought and sold.
Investors are able to put just small amounts of money into covered warrants. Indeed, in theory, you can invest just a few pounds this way, though you will have to pay a broker fee.
Investors are also able to enjoy exposure to both home and international markets through covered warrants.

Possible Downsides

Given the entirety of your investment could be lost, covered warrants are regarded as high-risk investments. As such, they suit experienced traders and those with money they can afford to lose.
Any gains made through covered warrants are liable to capital gains tax.
Compared to trading in stocks and shares, covered warrants are relatively complicated as well as riskier.

Trading in Covered Warrants

Covered warrants are issued by a large number of financial institutions and are listed as full tradable securities on the London Stock Exchanges (LSE). Among the big names offering this type of investment are Natwest and Barclay Stockbrokers.

The former, however, advises that “before trading, you should fully understand the nature of covered warrants and your exposure to the risk involved”.