Warrants - How the Professionals Invest

By Jason Fittler

"Warrants are not for everyone, but if you have the risk tolerance you can expect to receive a much better long term return."

Investors who have borrowed to invest in the Stock Market have experienced first hand the risks of gearing. But there are better ways of borrowing to invest.

Royal Bank of Scotland (RBS) Warrants

The new series of RBS Warrants are now structured to be competitive. The interest rates are the same as margin loan rates currently 7.85%. They also now have a stop loss built in, which means if the price of the underlying stock fall below the stop loss level you will exit at the stop loss. Because of this they are able to provide the Warrant at the lower interest rate.

So what does all of this mean, let’s take a look at the ASX 200 Index warrant (STW).

Example:

You have $10,000 to invest but you would like to maximize your return. If you purchased direct shares at the current price of $35 you could buy 285 shares. If you purchased warrants with the current price being $17.50 you could buy 570 shares. Therefore doubling your exposure, which means double the return and double your income.

Buying Shares

Cost (285 shares @ $35) $10,000
Dividend ($3.65 per share) $1040
Growth if market moves 10% $1000

Total Return 20% $2000


Buying Warrants

Cost (570 Warrants @ $17.50) $10,000
Loan $10,000
Dividend ($3.65 per warrant) $2080
Growth if market moves 10% $2000
Interest on loan -$785

Total Return 33% $3295

But want if the shares fall in price?

The market would need to fall to 1700 points for this warrant to be closed out, at this level if you had geared through a margin loan you would be in a margin call and the value of the shares would only cover the pay out of the margin loan.

If you owned the stock your $10,000 would now be $5,000. If the market falls below 1700 points you will lose the full amount you investment in the warrants, being $10,000 in the above example. If you geared up through a margin loan and the market fell below 1700 points, you could end up in a position where your portfolio is wiped out and you still owe money to the margin lender.

Warrants are not for everyone, but if you have the risk tolerance you can expect to receive a much better long term return.

If you are thinking about borrowing to invest make sure you take the time to find out more.

PS. Call us at ABN AMRO Morgans Townsville, 07 4771 4577 we are always ready to listen, explain and help.