Value a Covered Warrant (part 1)

When you buy a Covered Warrant you have to consider the exercise price and the expiry date.

Each Covered Warrant has an exercise price. This is the price at which you have the right to buy (call warrant) or sell (put warrant) the asset in the future.

This right doesn't last forever. Each Covered Warrant has a limited life-span which is determined by an expiry date. When that date has been reached then the warrant expires and its value (or not as the case may be) is realised.

During the life-span of a warrant its value can change dramatically.

The value of a Covered Warrant it made up of two things - the intrinsic value and the time value.

Intrinsic value

The intrinsic value of a Covered Warrant depends on the value of the underlying asset.

The intrinsic value of a call warrant is based on the amount the price of the underlying asset (eg share or index) exceeds the exercise price of the warrant. If the underlying asset price exceeds the exercise price then the call warrant is said to be 'in the money'. But if it doesn't the intrinsic value of the warrant is zero and it is said to be 'out of the money'.

In the same way the intrinsic value of a put warrant is based on the amount the price of the underlying asset falls below the exercise price of the warrant.

If the underlying asset price falls below the exercise price then the put warrant is said to be 'in the money'. But if it doesn't the intrinsic value of the warrant is zero and it is said to be 'out of the money'.

Time value

Just because a Covered Warrant is 'out of the money' at the moment, it doesn't mean that it will not be 'in the money' by the time it expires.

So the Covered Warrant also has a time value. This is based on the current value of the warrant less its intrinsic value.

In other words this is the value the market is putting on the Covered Warrant based on the possibility that it will end up being worth more than it currently is.

The time value of a Covered Warrant depends on the volatility of a warrant and its expiry date.

The more volatile a warrant or an underlying asset, the higher the potential warrant price - as a sharp swing could lead to the warrant ending 'in the money' in a big way. However, if a warrant is 'out of the money' and is less volatile, then the chances of it getting back into the money are lower and consequently the warrant price is likely to be lower.

The volatility of a warrant may change for a number of reasons eg company results, uncertainty about the group's future, management changes, the performance of the market or sector, dividend announcements, interest rate rises and falls and so on.