Comparing Covered Warrants and Turbos to Spread Bets

Q. What about Covered Warrants?

I am really considering buying a small amount in one which I am quite confident will reach its target by the deadline but before buying in, I want to make sure I properly understood the risk. I read several pages online and I am not sure anymore to understand the way they work :(

i.e.: Company xxx as a warrant ticker (xxxW) which will "activate" if the xxx sp reach 150GBX by December 2010. Let's say I buy 5,000 xxxW, if the share price does not reach 150GBX by the deadline, I simply lose my initial investment, correct? You cannot lose (be liable for) more than you initially invested right? Sorry for the dumb question but since I googled too much, I have a big doubt on how they work now :(


A: With covered warrants you can only lose your initial stake, I use them sometimes in commodities that whipsaw; whereas on a spread bet you would probably have had your stop triggered but with a covered warrant you know where you stand, so I tend to use them for reversal plays in currencies, commodities, and indices. They are usually touted as a tool to trade for maximum profit and limited risk; what they forget to tell you is that most options/warrants expire worthless.

I'd always suggest making sure each warrant is above 3p and under £10 and check the warrant has at least 60-90 days left to expiry - obviously they can also be used for shorting by using puts, so the benefits are no margin calls and you can magnify your gains. For instance at one point I had a 30% move that translated to 400% in a covered warrant ,but you do need to be careful as like spread betting this works both ways!

Another thing is to only buy 1 covered for each product - i.e. if they are offering 5 different FTSE options only consider 1 and so on, they are a useful instrument if you think you're right and can sit tight, not many investors can do both of these things, how often do you buy, it moves against you, you jump then it moves big and you miss out...

If you intend to hold a warrant to expiry, work out your breakeven price in the underlying share before buying. eg. If your covered warrant costs 12p with a strike price of 150p your break even figure will be 162p (assuming 1-1 parity). So on 18 Dec for every penny your underlying share closes below 162p you will lose £50. The people who do use covered warrants generally either do so to hedge an existing position/portfolio or for short term speculation.

Cash-settled covered warrants can be dealt through brokers in exactly the same way as shares - but they are free of the 0.5% stamp duty that is levied on share trading. However, unlike spread bets, covered warrants are liable to capital gains tax on profits (but this means that losses on covered warrants are also tax-deductible).

All UK covered warrants tend to be via Societe Generale or RBS and are tradeable via Selftrade, Barclays and Hargreaves Lansdown to name a few and you will need to fill in a form saying you understand the risks before a broker will allow you to trade them bla bla bla!

Q. How do Covered Warrants and Turbos compare to Spread Bets?

A: Both spread bets and covered warrants/turbos offer leverage. If Barclays' shares were to rise by 5 per cent, a Barclays covered warrants or turbo might rise by 20 to 80 per cent depending on the warrant/turbo purchased. Spread betting achieves gearing differently, by allowing the trader to specify the amount of money you wish to bet for each point movement in the price. Covered warrants/turbos do not attract stamp duty but any profits are subject to capital gains tax, unlike spread betting.

Charges for covered warrants and turbos are about 0.3% plus the dealing commission paid to the broker (which means they are more expensive than spread bets). Since they are listed on an exchange, the market for warrants turbos is however seen to be more transparent compared to spread betting.

A problem with covered warrants/turbos is that the prices of contracts are computed by a complicated formula connected to factors like time-decay (since covered warrants have limited lives) and market volatility. On the other hand with a spread bet you can immediately keep track of your gains/losses by looking at the prices of the underlyg assets which mirror the underlyings.

With a covered warrant, your maximum liability is limited to your initial outlay and the upside is unlimited. A spread bet which moves against you can cost you a lot more than your initial stake, and you may be required to deposit more monies to cover the losses that you have piled up. Having said that, in practice the use of stop loss orders in spread betting does put a cap on losses and you can spread bet on a range of far more financial assets than you can with a covered warrants.

 ...Continues here - Likelihood of Spread Betting becoming Taxable?

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