Investment Trust Warrants
Investment Trust derivatives: Warrants
Investment trusts are collective investments similar to mutual funds or unit trusts, but generally with lower fees and are actual investment companies with shares that can be traded, rather than units representing the underlying investment holdings (See my related article for a detailed description of these). When these investment companies are created they often issue warrants to the initial share-holders to help finance the launch of the company.
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 and the similar Subscription Shares which are issued later in the company's life to raise funds.
Disclaimer: Information in this and other linked articles is unregulated and for general information only and is not intended to be relied upon in making specific investment decisions. Appropriate independent advice should be obtained before making any such decision.
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.Is the share price above the strike price ("In the money")Is the share price below the strike price ("Out of the money")If not, what is the chance of the price rising to the strike priceIf the price remain below the strike price the warrant is worthlessIf the price rises by x% how much will the value of the warrant increase?
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):ABERDEEN ASIAN INCOME (31 May 2013)ABERDEEN LATIN AMERICAN INCOME LTD SUB (31-Dec 2013)BLUE PLANET FINANCIALS GROWTH & INCOME (31 July 2010)CITY NATURAL RESOURCES HIGH YIELD (31 Oct 2009)FINSBURY WORLDWIDE PHARMACEUTICAL TRUST (31 July 2009)HENDERSON OPPORTUNITIES TRUST (15 Feb 2014)IMPAX ENVIRONMENTAL MARKETS (15 June 2010)INVISTA EUROPEAN REAL ESTATE (30 September 2011)JP MORGAN INDIAN IT PLCJP MORGAN PRIVATE EQUITY (30 June 2014)JUPITER GREEN IT PLC (31 July 2011)LAZARD WORLD TRUSTMIDAS INCOME & GROWTH TRUST (31 Aug 2010)NEW INDIA IT (30 June 2010)PERPETUAL INCOME AND GROWTH INVESTMENT TRUST PLCRCM TECHNOLOGY TRUST PLCSR EUROPE INVESTMENT TRUST PLC
Black and Scholes Option Pricing Model
The Black Scholes option pricing Model:
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)
d2=d1 - sSQRT(t)
s=standard deviation of stock returns
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