KUALA LUMPUR: Fitch Ratings’ decision to revise its outlook on the country’s sovereign rating to “stable” from “negative” and reaffirm the rating at A-, sent the FBM KLCI surging 21.32 points yesterday to 1,727.96. However, put warrants, which are known to perform best in bear markets, went in the other direction.

Local put warrants such as the FBM KLCI-HR Index fell 15.43%, FBM KLCI-HF Index (-13.1 %), FBM KLCI-HH Index (-16.06%), FBM KLCI-HI Index (-10.4%), FBM KLCI-HS Index (-15.04%), FBM KLCI-HL Index (-18.63%), FBM KLCI-HT Index (-13.13%), FBM KLCI-HM Index (-18.75%), FBM KLCI-HP Index (-16.67%), and FBM KLCI-HB Index (-17.86%).

On the contrary, the bearish performance of China stock markets pushed up their put warrants yesterday, with the FTSE China A50-H2 gaining 23.53%, the FTSE China A50-H4 gaining 28.34%, and the FTSE China A50-H3 rising by 23.08%.

Inter-Pacific Securities Sdn Bhd senior dealer Sam Ng likened structured warrants to “casino products” due to their speculative nature, as a wrong judgement could lead to risky investment decisions.

“Taking the recent jump in the KLCI for example, investors who were speculating on a bear market would have put their money into put warrants, as these instruments allow investors to profit in a bearish market, and with Fitch Ratings affirming the country’s credit rating and pushing up the FBM KLCI, this certainly did not bode well for put warrant investors,” he said.

The local bourse also saw an active trade of call warrants, with the FBM KLCI-CZ gaining 30.56%, the FBM KLCI-CS (+38.46%), the FBM KLCI-C2 (+30.77%), and the FBM KLCI-CT (+21.05%).

Areca Capital Sdn Bhd chief executive officer Danny Wong referred to structured warrants as a short-term leveraging tool for investors, as their prices are low and therefore the leverage they offer is high, making room for potential capital gains.

“Investors who are sceptical about the performance of a certain underlying security, or “mother share”, may invest in call warrants, so that if their judgements are correct and if the mother share does not perform up to par, it is less impactful financially to them,” he said.

Macquarie Capital Securities (M) Sdn Bhd representative for derivative sales Johann Sze said investors need to be aware of two primary risks when investing in warrants, which are the market risk and time decay factor.

“Market risk is the risk that the warrant price moves against the investor, as due to the gearing effect, warrants tend to move in greater percentage than their underlying [security], and this can translate into greater potential returns, however it also means an increased level of risk,” said Sze.

He added that there is a time decay factor, as warrants have a limited life and will lose value over time if the underlying security does not move in the investor’s favour.

“For this reason, investors need to use warrants for short-term horizons only,” said Sze.

This article first appeared in The Edge Financial Daily, on July 02, 2015.