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Investment Trust derivatives: Warrants
These warrants are long-dated call options (or covered call warrants in the UK) with a strike-price typically the same as the launch price of the share providing a highly geared (leveraged) exposure to the underlying investment. There are very few of these in existence (about 10 at time of writing) These are more difficult to trade, due to low-liquidity and tend to have wide bid-offer spreads. Their value can be determined using normal option-pricing methods (e.g. Black Scholes option pricing) based on length of time to maturity and share price.
This article is about how to invest in these riskier investments.
Table of Contents: Investment Trust Warrants
Investment Books
Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions (Wiley Finance)
Amazon Price: $50.40 (as of 12/18/2009) 
The Motley Fool Investment Guide for Teens: 8 Steps to Having More Money Than Your Parents Ever Dreamed Of
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The Smartest Investment Book You'll Ever Read: The Simple, Stress-Free Way to Reach Your Investment Goals
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Options as a Strategic Investment
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Essentials of Investments with S&P bind-in card (Mcgraw-Hill/Irwin Series in Finance, Insurance and Real Estate)
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How Warrants Work
Investment trust warrants are call options on the underlying Investment trusts usually issed with a very long life (e.g. several years) and a strike-price the same as the IT launch price. Investment trusts usually trade at a discount, so prices generally fall after launch until the net-asset value of the company has increased above the launch price. The warrant is tradable and its value is determined by market forces, but on exercise at the end of it's life it will be worth the difference between the share price on that date and the strike-price (i.e. the gain in the share-price over that period)There are very few sources of information concerning investment trust warrants, but the best web-site is probably TrustNet This gives a useful table of all of the remaining warrants and their prices, strike prices etc.
The value of IT warrants can be determined using normal option-pricing methods (e.g. Black Scholes option pricing - see module below and My separate option pricing article) based on length of time to maturity and share price, but the above table gives the current market price. The simple way to approximate the value of the warrant is to consider the following.
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Investment Trust Warrants Currently Available
Here are the investment trust warrants currently available (at time of writing) and the date on which they can be exercised (if available):Black and Scholes Option Pricing Model
C=SN(d1)-Ke^(-rt)N(d2)
C=Theoretical Call Premium
S=Current Stock Price
t=time until option expiry
K=option strike price
r=risk-free interst rate
N=cumulative standard normal distribution
e=expoential term (2.7183)
d1=(ln(S/K)+(r+s^2/2)t)/sSQRT(t)
d2=d1 - sSQRT(t)
s=standard deviation of stock returns
Assumptions:
1) The stock pays no dividends
2) European exercise terms are used (option can only be exercised on the expiration date)
3) Markets are efficient.
4) No commissions are charged
5) Interest rates remain constant and known
6) Returns are lognormally distributed
For a full description of how this is derived and a simple explanation see this article...
Investment Books - Option Pricing
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- AndyPo AndyPo Nov 13, 2009 @ 4:42 pm
- JPMorgan Fleming Japanese Smaller Companies Investment Trust warrants look very interesting (JPSS): exercise price of 135p until March 2010 (then 135p to March 2012, then 174 until March 2014) current warrant price of 29.5p and share price of 137. It could of course expire worthless, but may be worth a punt?
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