Investors snap up DWs

Investors snap up DWs

Volatile financial markets have made derivative warrants trendy, but high-frequency trading may blunt their appeal, writes Nuntawun Polkuamdee

In a year defined by instability in financial markets and in the country at large, investors are rushing to buy a trendy financial instrument popularised in Hong Kong that rewards volatility at the expense of the financial institutions that issue them.

Sold by securities firms for a set premium, derivative warrants (DWs) give investors the right to buy or sell a stock at a preset price by a certain expiry date. The instrument can minimise risk because investors are not obligated to take action at the end of the expiry date if the stock price is unfavourable, and their losses will be limited to the cost of the premium.

The trading value of DWs reached a record high of 6.5 billion baht per day this year on the Stock Exchange of Thailand, representing about 10-11% of the total market trading valuation.

The instrument has grown into a useful tool for those seeking profits among high market volatility.

In the first quarter the SET index plunged to a low for 2020 of 28.7%, while year-to-date the SET has dropped 17%.

DWs are listed on the SET and can be a profitable investment in any market for savvy investors. If the market is going up, investors can buy call DWs, which allow them to potentially buy stocks at a lower price than the market.

Put DWs on the other hand allow investors to sell stocks at a later date, and are valuable in a downward trending market. DWs can also be bought and sold before their expiry date.

DWs are widely popular in Taiwan and Hong Kong, as both markets have large numbers of retail investors similar to Thai markets.

It is also a leveraged product, which means the investment capital in a DW is less than investing in the underlying stock directly, which would yield greater returns coupled with greater risks.

DWs have been gaining popularity on the SET for over a decade. The trading value of DWs averaged 6.2 billion baht per day in 2019, trading at about 15% of the SET's total trading valuation.

In 2020, DW trading represents about 11% of the SET's total trade at 6.5 billion baht per day, said Jenwit Chinkulkitnivat, managing director for equity derivative business at KGI Securities.

The DW trading percentage only decreased this year because the SET trading value increased by 50-60 billion baht per day compared with last year.


Mr Jenwit said the securities firm's DW business, which issues DWs to investors, actually lost money for the first time because of the first quarter's unusually high volatility and the Covid-19 pandemic.

SET volatility hit an all-time high of 70% in March when the market dropped 16%, 15-30% above the annual average volatility over the past 10 years.

However, market volatility eased in the second quarter and DW issuers expect a return to profit in the second half based on the expectation the SET index will return to its average volatility of 15-30%.

Another challenge for issuers is the uptick in high-frequency trading (HFT) investors, mostly foreign, trading DWs through algorithms that are outsmarting the trading programs used by local issuers.

"The high market volatility is a risk beyond our control, but HFT is a challenge we can cope with as DW issuers by upgrading our company's technology and trading platforms," Mr Jenwit said.

"However, domestic retail investors generally do not have access to technology like high-speed trading tools used for DW investment."

He expects securities firms that issue DW products (about 10 companies out of 38 securities firms in Thailand) to make a return to profit later this year. KGI currently has 300-400 outstanding DW series.

KGI controls 40% of the DW market share in Thailand in terms of product volume, making it the market leader. The company plans to issue a new DW series of more than 500 series DWs, a record high for the company since it started issuing the warrants 11 years ago.

But while issuers are losing out, investors can see returns from put DWs in a bearish market or call DWs when the market rebounds. Because there is no obligation to buy or sell, investors can hedge their portfolios from heavy losses if they make the wrong call.

However, investment conditions of DWs and futures contracts on the Thailand Futures Exchange are quite different. Investing in futures contracts follows capital maintenance rules and they have a capital size bigger than DWs.

If the forecasts are correct that SET volatility will return to normal levels in the second half, securities firms will likely issue new series of DWs again for the remaining months of the year, as market stability works in their favour.

Bualuang Securities (BLS) managing director Bannarong Pichyakorn said the company also lost money issuing DWs in the first half for the same reason as KGI: volatility and foreign HFT.

In response the company delayed launching a new series of DWs. BLS's DW series declined from 300-400 outstanding series to only 63 series currently.

However, the company is now ready to return to the market and plans to issue new DWs this month.

Mr Bannarong said the DW market will likely shrink as HFT has insurmountable technological advantages and ends up controlling DW prices, scaring away the average investor.

"Retail investors are already leaving the DW market to trade common stocks again, as prices are cheap at this time," he said. "Retail investors make up 50% of the SET, up from below 40% at the beginning of the year."


The market is expected to remain highly volatile the rest of this year, meaning call DWs and put DWs will likely be active, said Mr Jenwit.

He predicts DWs will remain the most popular product on the SET index and represent single large-cap stocks as underlying assets.

Mr Jenwit said call DWs will prove extremely profitable if a successful Covid-19 vaccine is produced because it will cause markets worldwide to surge and allow the DW holder to buy in at lower prices. Other factors making these warrants attractive are if interest rates remain low, economic factors improve and domestic political tensions ease.

While being profitable for an investor, the success of put DWs is contingent on negative outcomes for society, such as a second wave of infections, the US-China trade war heating up and domestic political tensions exacerbating towards violence, he said.

The DW investment comes down to a choice between optimism and pessimism, said Mr Jenwit. Investors can choose SET index DWs or DWs with structures on single large-cap stocks of underlying companies such as Sri Trang Agro (STA), KCE Electronics (KCE), Airports of Thailand (AoT) and Minor International (MINT).

These stocks in particular are beset with a mix of negative and positive news stories about their financial and business prospects, so volatility remains high enough to give investors the chance to predict the price direction, he said.

DWs could be underpinned by Thai stocks available on the SET50, SET100 or SET High Dividend 30, or by foreign stocks on the HSI index.

The nearer a DW gets to its expiry date, the less valuable it becomes as there is less time for speculation on market volatility.

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