By Sandra Lee, Vice President, Deutsche Bank
The demand and supply of warrants should not typically have a material impact on the warrant price. The theoretical warrant price is based on the widely used Black and Scholes option pricing model and deviation from the theoretical price should lead to increase demand (with market maker or investors buying the warrants) or supply (by the issuance of additional warrants or market maker and warrant holders selling their warrants) which should bring the warrant price back to its theoretical level.
However, the demand and supply of the underlying share of a warrant as indicated by the bid-offer spread and the sizes of the bid and offer have a bearing on the warrant price. In the following we will discuss how they affect the warrant price.
Bid-offer spread of the underlying share
The bid price is the price at which investors are willing to sell their shares and the offer price is the price at which they are willing to buy the shares. Under the rules of SGX, shares at different prices trade with a different minimum bid-offer spread. The below table shows the minimum spread of shares trading at different prices that are listed on the SGX.
| Market Price |
Minimum Spread |
| Up to $1.00 |
0.5 cents |
| Up to $3.00 |
1 cent |
| Up to $5.00 |
2 cents |
| Up to $10.00 |
5 cents |
| Above $10.00 |
10 cents |
One can derive a “fair” bid and offer spread on the warrant by observing the bid and offer of the underlying share. This is obtained by dividing the bid–offer spread of the underlying share by the conversion ratio of the warrant.
Take for example Singapore Press Holdings (SPH). The share was trading at $4.28 and the minimum bid- offer spread in the share was $0.02. Most SPH warrants are issued with a conversion ratio of 1 warrant to 1 share. By the simple calculation, the “fair” spread on the warrants is $0.02 (0.02/1).
Now, let’s look at shares of Singapore Airlines. They trade at prices above $10.00 and the minimum bid-offer spread for the share is $0.1. If warrants on Singapore Airlines are issued with a conversion ratio of 10 warrants to 1 underlying share, then the “fair” bid-offer spread in the warrants is $0.01 (0.1/10).
The conversion ratio of a warrant shows the number of warrants to 1 underlying share.
While a smaller conversion ratio generally means the warrant price is more sensitive to the movements of the underlying share, a smaller conversion ratio often implies a wider “fair” bid-offer spread. This can be seen from the following comparison. Deutsche Bank has warrants on Singapore Airlines with a conversion ratio of 5 warrants to 1 share. Given this smaller conversion ratio, the fair spread in the warrants is then $0.02 (0.10/5).
For less liquid underlying shares and on quiet trading days, some shares tend to trade at wider bid- offer spreads than the minimum spreads. When this is the case, it is normal for the bid-offer spread on the warrants to be correspondingly wider as well.
It is therefore important for investors to note when comparing and trading different warrants on the same underlying share or index, that care should be taken of what is the “fair” bid-offer spread in the warrants with respect to the conversion ratio of the warrant and the bid-offer of the underlying.
The bid-offer size of the underlying share
The bid and offer size in the share at a particular price reflects the investors’ interests on the share at that price. For a share with very strong buying interest, we will usually see a large size queuing to buy at the bid price.
Take a look at the following queue order table for SPH shares. The two-way price quoted in the market is $4.28 - $4.30. Suppose an investor wants to buy 50,000 shares of SPH right away, is he able to be filled all $4.30? The answer is clearly no since there are only 25,000 shares being offered at this price. He may have to buy the remaining 25,000 shares at the next best offer price of $4.32 and by doing so, his average purchase will be $4.31.
| Bid Size |
Best bid |
Best offer |
Offer Size |
| 52,000 |
4.28 |
4.30 |
25,000 |
| 88,000 |
4.30 |
4.32 |
102,000 |
| 163,000 |
4.32 |
4.34 |
80,000 |
Let’s look at how this applies in warrants trading. When an investor buys 100,000 call warrants, the trader hedges by buying the underlying shares. Assume a conversion ratio of 1 warrant to 1 share and a delta of 0.5, the trader will need to buy 50,000 shares.
Therefore, when the trader sees from the market that there are only 25,000 shares being offered at $4. 30, he has to decide to quote either an offer size for 50,000 warrants using a share price of $4.30 or an offer size for 100,000 warrants using a higher share price of $4.31. The result in choosing the latter will lead to a wider bid-offer spread on the warrants.
It is reasonable to expect that if the underlying share has large bid and offer sizes, then the warrant should also be quoted with large bid and offer sizes. However, this is not the full picture. In the above example, we assume a delta of 0.5. For warrants that are trading deep in-the-money, the (absolute) delta value is larger and a larger number of shares will be purchased or sold for delta hedging. Hence, it can sometimes be observed that warrants that are trading deep in-the-money have wider bid-offer spreads. The suggestion for investors holding onto deep in-the-money warrants may be to switch out of the warrants into another one that is trading at-the-money or out-of-the-money.
In summary, we see how demand and supply of the underlying share as indicated by the bid-offer spread and bid-offer size affect warrant prices and when market makers quote their prices, they will take the above factors into account.
Article written by Sandra Lee, Vice President Deutsche Bank
Note that all issues and share prices used in this article are for example only.
This material, and the information contained therein, is provided for informational purposes only. It is not to be construed as an offer to buy or sell or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy in any jurisdiction. It does not constitute a recommendation or the provision of investment advice. The financial instruments discussed may not be suitable for all investors and investors must make their own investment decisions using their own investment advisors as they believe necessary and based upon their specific financial situations and investment objectives.
© November 2006
Deutsche Securities Asia Limited
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