*** Only 4 days left till the launch…

*** 7 successful warrants plays...

*** What to say to your broker… and more...

From the still chaotic desk of Julie Brownlee

Dear Investment Academy Reader,

It's not long now! We're counting the days to the launch of our new Fleet Street Publications website - which goes live next week. We're all in a bit of a tailspin in the office at the moment. Everyone's working furiously trying to get everything finalised - and you're not going be disappointed! As well as being able to view past issues of the Investment Academy in our new e-letter archive, the website's jammed packed full of new features. We've officially entered the 21st century and you'll be able to order our products online!

We'll let you know once it's ready for you to visit and we look forward to hearing your thoughts on its new look and features. But, back to business. We've been looking at warrants and, in today's second last visit on the topic for a while, you can't even think about making money with warrants until you find someone to trade them through...

Your broker

Choose your broker wisely. You may already have a broker you trust. If so, excellent, but make sure he has experience buying, selling and exercising warrants. And above all, don't forget to ask about commission rates.

Whenever you buy a warrant, there's a commission charged.

Whenever you sell that warrant back into the marketplace, there's a commission charged. The size of that commission adversely affects your capital. If you go with a full-service broker, expect to pay higher commissions. But, on the plus side, you can also expect a wider range of services and you're likely to receive more personal attention. Discount and online brokers often charge less commission but, for the most part, you're on your own.

At first glance, you may think it's wise to confine your warrants buying activity to a discount or online broker. But this might cost you thousands of rands if your service broker at the discount house can't execute your orders quickly or keep track of your positions. You'll find it often pays to conduct your warrants business with a broker knowledgeable about warrants markets - and who really cares for customers who take warrant-buying risks.

If you want to stay with your broker, see if you can get a reduced rate on your warrants trades. Years ago, there were fixed commissions for warrants as well as stocks. But today, even the largest brokerage firms will set a lower rate for your warrants commission if you're a volume buyer. But whoever your broker is, you can't buy warrants unless you've filled out certain paperwork. Make sure you read the literature your broker's required to give you, fill out the forms and set up a cash account with enough money to pay in full for the warrants you want to buy.

Terms of the trade - market or limit?

Now you're ready to trade. When you're ready to purchase a warrant, you instruct your broker to buy to open. This means you're making a new fully-paid-for warrant position which, when executed, will be entered into the exchange computer. You can tell your broker to buy the warrant immediately, paying whatever the going rate is. This is called a market order.

Or you can set a limit price when you place your order, meaning that your order won't be executed until the warrant hits a certain price. This is known as a limit order. I prefer limit orders. Your order might not get filled, but your risk is known and there are always other opportunities in warrants.

For example, if you tell your broker to put in a market order to buy a March 2500 call warrant on Widget Co. to open, you'll pay whatever the current warrant price is. If the warrant's price is moving fast, your order could be executed for far more than you'd be willing to pay otherwise.

On the other hand, if you tell your broker to put in a limit order to buy a March 2500 call warrant for a premium of R1,100 to open, your trade won't be executed unless the price is below R1,100. Your risk is kept firmly in check, since you know almost exactly how much you're paying for the warrant. Unfortunately, this also means there's a chance your warrant order will never be executed. The premium may never fall below R1,100.

Don't forget about an order

Another thing to remember is to cancel an order you're no longer interested in. If your order is still in your broker's computer when the limit price is hit, you'll buy the warrant.
 
For instance, you instruct your broker to buy a Widget Co. March 2500 call warrant for a premium of R1,100 to open. When you call your broker, the warrant's at R1,050. But by the time your broker's ready to execute the order, the price is R1,150. So your order remains in the computer unfilled. A day later, the warrant's jumped to R1,800 - and your order is still unfilled and still in the computer. Two weeks later, the price collapses. When it hits R1,100, the order's executed. Without meaning to, you've now spent R1,100 on a warrant that's already doubled and is now sinking.

This is an extreme example, but it illustrates two important points.

Using limit prices is a much better idea than not using them. But you must set a sensible limit price. Make it big enough to account for volatility, but not so wide that you lose profits. Above all, keep track of all your outstanding warrant orders and cancel ones that turn against you.

When it's time to sell your warrant, tell your broker to resell to close the position. You sell your warrant to the market, receiving money in exchange for giving up your rights to the underlying investment without gaining an obligation. You can sell for a profit or for a loss, depending on what the market's willing to pay, but either way, you're out of the game. Make sure you get the phrasing right! Remember, warrants originally come from an investor looking to make money by writing, or selling, warrants to other investors. If you don't make it clear that you're closing an open position, not opening a new one by selling a warrant, you may accidentally become a warrant writer. And warrant writers have an obligation to fulfill the terms of an options contract.

Protect your losses

You can also give your broker a stop loss order. This is an instruction to your broker to resell your holding if the price falls to a certain level to prevent further losses. This helps limit your risk and lock-in gains. If you bought your warrant at R1,100 and it goes to R2,000, you might tell your broker to put in a stop loss at R1,500. If the price hits R1,500, your broker will execute a sell order. The upside is that you're almost guaranteed retaining your profits. But, keep in mind, the stop loss only tells your broker to start executing the order. If the warrant's dropping rapidly, the price could be below R1,500 by the time your order hits the trading floor.

Finally, of course, you might choose to exercise your warrant at anytime.

If you own a successful call and wish to take possession of the shares at the lower than market price, instruct your broker to exercise your call and position the shares in your portfolio at the strike price of the call.

Make sure you have enough cash in your account to buy the shares, and don't forget that with stock warrants you're buying 1,000 shares of the stock. Conversely, if you've bought a successful put, tell your broker to exercise your put and sell the shares, crediting your account for the proceeds at the stock price.

Generally, only look to exercise a few days before expiry if you decide to go this route. In most cases, though, warrants are traded rather than exercised, picking up on the time value. You can usually look to sell up to three months before expiry.

If a trade goes against you and you're unable to sell your warrant (bid goes to 0), then it'll expire worthless. There's nothing you or your broker can do in this case.

The 7 keys to successful warrant plays

** Don't be greedy; small profits never hurt anybody.
** Protect principle by setting sensible stops.
** Never lose more than 50% of the premium if you can help it.
** Watch your warrant positions daily or have your broker do this for you.
** Don't overbuy any warrant position.
** Don't overpay for any warrants.
** Understand warrants pricing.

OK. Now you know what a warrant is. You know why warrants can be so profitable. And you know how to talk to your broker. If you're still unsure about any of this, ask your broker for more information - you're paying him to help you.

When to buy and sell

The first thing to consider is how many of each warrant you should buy. Because of the power of leverage in warrants, there's almost always an instinct to overbuy. That is, greedy investors buy up lots of warrants because of the chance of a huge return. Resist that temptation. Let me explain.

Yes, warrants offer the chance for a super return, but they also offer greater risk. Only use speculative capital - money you can honestly afford to lose - to play warrants. And even then, don't overbuy. Placing too much money in one warrants play will rob you of capital to put in another warrants play.

Next Friday, we'll wrap up our look at warrants with the icing on the cake - winning strategies. Until then...

Happy trading!

Julie Brownlee
For the Investment Academy

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