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The difference between buying warrants and buying underlying stocks

We use Ping An Insurance as an example to calculate the difference between buying warrants and buying underlying stocks.

On November 8, 2004, Ping An Insurance's stock price was 12.4 Hong Kong dollars, and the stock price was in an upward channel. Both investors, Mr. S and Mr. W, are bullish on the stock price of Ping An Insurance. The former bought the underlying shares and the latter bought a related warrant A at a price of HK$0.78. Ping An Insurance has 500 shares per board lot. About half a month later, Ping An Insurance's share price rose to 13.5 Hong Kong dollars, and Warrant A rose to 1.41 Hong Kong dollars. We use a table to calculate the return on investment of two investors.



As can be seen from the above table, the investment cost of warrants is lower than that of the underlying stocks, but the rate of return is significantly higher. This is the performance of the warrants' "Invest less and earn more" and is the most attractive feature for investors.If calculated in terms of amount, the absolute amount of profit from investing in underlying stocks is relatively large, but the cost of investment is also several times the amount of funds invested in warrants. In the above case, investing in 500 underlying shares requires an amount of 6,200 Hong Kong dollars, while investing in 500 warrants only requires 390 Hong Kong dollars.


Let's calculate the negative example again, that is, the situation where the investment is lost in the wrong direction.

It can be seen from the above table that if investors misunderstand the market outlook, the loss of warrants will be higher. Therefore, warrants are a double-edged sword and must be used with care. But the biggest loss of warrants is all the invested funds. If the worst happens, Mr. W will only lose the entire cost of HK$650. On the other hand, the absolute amount of loss of HK$300  is also less than the HK$550 of investment losses.On December 28, 2004, the stock price of Ping An Insurance was 13.5 yuan. The two investors, Mr. S and Mr. W, were still bullish on the stock price of Ping An Insurance. The former bought the underlying shares and the latter bought a related warrant A. The price at that time was HK$1.3.  However, the stock price trend was different from the judgment of investors. About half a month later, Ping An Insurance's stock price fell to 12.4 Hong Kong dollars, and the warrant B fell to 0.70 Hong Kong dollars. The two investors stopped their losses and went out.

To sum up, investing in underlying stocks generally costs more capital and lower investment returns, but the risk is also lower; investing in warrants costs less funds and higher investment returns and the risk is also depends on the investment fund.