Derivative Warrants are very popular investments worldwide, especially in Germany and in Asia such as Hong Kong, Taiwan, Singapore, and Korea. In Thailand, Derivative Warrants SCB-C1 and SCIB-C1 were issued by the Financial Institutions Development Fund (FIDF) and were very popular with investors many years ago. KGI became the first brokerage to issue a Derivative Warrant (PTT13CA) in Thailand, in June 2009.

• Like an option or a traditional warrant, a DW is securities that give the holder the right but not the obligation to buy/sell an underlying asset at an agreed price at specified time.
• The issuer of a DW is a financial company authorized by the SEC to issue DW, not the underlying company of the DW, for example, Securities Company.
• Normally, underlying asset is stock, index, basket, or ETF.
• There are two types of DW which give the right to buy (Call Warrant) and the right to sell (Put Warrant) the underlying asset.
• There are 2 types of settlement, Physical & Cash Settlement.
• There are 3 types of collateral held by issuer which are Fully-Collateralized, Partial-Collateralized, and Non-Collateralized.
  

Example
DW of ABCD Co, Ltd. issued by KGI #Series A (Call Warrant)

On 1 July 09, if an investor has 1,000,000 Baht, investor can

• Option 1 Invest in ABCD, buy 10,000 shares at 100 Baht (10,000 x 100 = 1,000,000 Baht) or

• Option 2 Invest in ABCD13CA, buy 200,000 units at 5 Baht (200,000 x 5 = 1,000,000 Baht)
  
  On 26 Dec 09, if price of both securities are;
   Price of ABCD           :               120  Bath
   Price of ABCD13CA   :                 10  Bath

The investor can profit on each option as follows;

• Option 1  if investor sells ABCD at 120 Baht, profit will be 200,000 Baht (10,000 x (120-100)) or 20%
• Option 2  if investor sells ABCD13CA at 10 Baht, profit will be 1,000,000 Baht (200,000 x (10-5))  or 100%
  

Basically, with the same amount invested, if the price of the stock goes up, investing in a DW will give a higher return than investing in the stock. However, investor should aware when the price of the underlying stock goes down, investing in the DW will suffer a greater loss than investing in the stock too.

2)   Managing Investment Capital: Where an investor already owns the underlying shares of the DW, the investor can switch from the underlying shares to the DW, which requires a lower investment. Thus the remaining capital can be invested in other securities for higher return.
Example
If an investor has 10,000 shares of ABCD, he can sell all the ABCD shares at 100 Baht and buy 10,000 units of ABCD13CA at 5 Baht. The investor will still gain when ABCD share price goes up and he will also safe keep 950,000 Baht (1,000,000 – 50,000)

3)   Unlimited Gain with Limited Loss: The maximum loss a DW holder faces is the original purchase price. However, there is no limit to the up side as the DW value will increase in line with the underlying share price.

On the exercise date, if the market price of the underlying share is above the exercise price, the DW is “in the money”, the DW will automatically be exercised and the holder will receive cash (Cash Settlement) from the issuer. DW holder does not need to   submit any documents as the exercise is automatic.  
Example
Investor has DW 1,000 units with underlying asset price of 15 Baht, exercise price of 10 Baht, and exercise ratio of 1DW :1stock. On maturity the holder will receive cash payment of 5,000 Baht ((15-10) x 1,000).

1)   Credit Risk: If the DW exercise price is above the market price on the exercise date, the DW holder will receive a cash payment from the DW issuer. Credit risk refers to the risk that the issuer is unable to make the payment on maturity. To minimize this risk, the SEC must approve every DW issuer before any issue. Each DW issuer must also have an investment grade credit rating.

Factor	Up / Down	Effect on DW Price
Price of Underlying Asset
Volatility
Time to Maturity
Interest Rate
Dividend

The issuer can use the DW to manage its risk. The issuer will partially buy the underlying asset to reduce its risk. If the price of the underlying asset increases, the value of the underlying asset held by issuer will also increase. On the other hand, if the price of the underlying asset decreases, the issuer may sell the underlying asset. When a DW is traded on the SET the brokers involved will charge a commission – the commission is fixed at 0.25% regardless of whether the broker is the DW issuer or not.

Investors can buy and sell DW just the same as other shares and warrants listed on the SET. There are two ways to buy a DW:
1)   In the IPO
2)   On the SET after trading starts