Trading in warrants is more complex than dealing in stocks, although both are conducted through the Stock Exchange of Hong Kong (SEHK).
What are the differences in the trading procedure for warrants and stocks?
Except for direct business transactions, your orders must be placed through the SEHK's Automatic Order Matching and Execution System (AMS/3) when you trade either stocks or warrants. All orders are automatically matched and executed on the basis of price and time priority. Both stock and warrant transactions are settled on T+2 (T being the trade date).
However, there are certain differences you need to be aware of:
Liquidity Provider: A warrant issuer must appoint a liquidity provider for each derivative warrant issued. Before you place an order, you can check if the liquidity provider provides active bid or ask quotes (active quotes) or you have to call the liquidity provider to ask for a quote (quote request). No such mechanism is in place for trading stocks.
No short selling is allowed: Derivative warrants are not designated securities eligible for short selling. Therefore, except for the liquidity provider, it is illegal to sell a warrant which you do not own and then buy it back on the same day.
Exercisable right: Unlike stocks, warrants give their holders the right to buy or sell the underlying asset. Only cash-settled derivative warrants which are in-the-money on expiry will be automatically exercised. Otherwise, you need to give instructions to your brokerage to exercise your warrants.
Stamp duty: Trading in stocks (except for the seven Nasdaq stocks traded under the Stock Exchanges pilot programme) are subject to stamp duty, payable by both the buyer and seller in a transaction. However, stamp duty is not chargeable for trading cash-settled derivative warrants, or warrants issued over assets other than stocks.
How can I benefit from the liquidity providing mechanism?
Issuers should appoint a liquidity provider for every derivative warrant they issue. A liquidity provider can provide liquidity by responding to requests for quotes (quote request) or by actively inputting orders into the Exchange's trading system (active quotes). If your warrant adopts the method of quote request and, when there are no bid or ask quotes provided by the liquidity provider, you can call for a quote at the phone number shown on the listing document, the HKEx website and the designated page of the warrant (see below).
Can I sell a warrant on the expiry day?
Note that the expiry day, which is equivalent to the last listing day, is not the same as the last trading day. To ensure that a trade executed has sufficient time to be cleared and registered, three settlement days are set between the last trading day and the expiry date. Investors can only trade on or before the last trading day. For instance, if a warrant expires on 10 June (Friday), the last day of trading falls on 6 June (Monday), assuming all the days in the period are settlement days.
To remind investors of these two important dates, issuers need to publish an announcement at least seven business days before the expiry day on the HKEx website. Bear in mind that you can only trade a warrant on or before its last trading day. So, remember to check the last trading day if you want to sell a warrant before expiry.
What should I pay attention to in exercising a warrant?
American vs. European: With an American warrant, you can exercise it on or before the expiry day. Whereas, an European warrant can be exercised only on the expiry day. As a rule of thumb, you exercise a warrant only if it is in-the-money.
Cash vs. Physical settlement: Derivative warrants can be settled by either cash or physical delivery. Usually, derivative warrants on a basket of stocks, an index, a currency, a commodity, a futures contract (e.g. oil futures), and stocks listed overseas are cash-settled. Derivative warrants on a single stock listed on the SEHK can be either cash or physically-settled, but in practice, most are cash-settled. Subscription warrants involve physical settlement.
Cash-settled derivative warrants are automatically exercised on the expiry day if they are in-the-money. The net cash settlement amount will be paid to you within the prescribed time as stated in the listing document. In deducing the cash settlement amount, for standard derivative warrants whose underlying stocks are listed on the Stock Exchange, the exercise price is compared with the average of the closing prices of the underlying stock for the five trading days up to and including the trading day before the expiry day. For exotic warrants and standard warrants, which are linked to stocks that are not listed on the Stock Exchange, or linked to assets other than stocks (e.g. an index, a futures contract), refer to the listing document for the valuation formula.
In the case of a physically-settled derivative warrant, it can be exercised only upon your instruction. Note that you may have to wait for a certain period before receiving the underlying shares after exercising a call warrant on a single stock. So, you are subject to the risk of fluctuations in the share price between the exercise day and the day on which you receive the shares. If you hold a physically-settled put warrant on a single stock, you have to be able to deliver the underlying shares on the exercise day.