This article first appeared in The Edge Malaysia Weekly on July 20, 2020 - July 26, 2020

MUCH has been written about how retail investors have embraced this market rally with gusto. They are credited with bringing back the bull market after stocks plunged in March when the economy shut down, owing to lockdowns to curb Covid-19.

Many have seemingly outperformed professional asset managers, who are reportedly still sitting on higher-than-average cash in money market funds. But have these retail investors, particularly the newer amateurs, also unwittingly taken on more risks than they realise?

As with penny stocks, warrants are very popular among retail investors. Owing to their gearing ratios, investors can get exposure to the underlying stock at a fraction of the price of the mother share.

Most of the warrants currently trading on Bursa Malaysia are structured call warrants, which give the investors the option — but not the obligation — to buy the underlying stocks within a specified time frame.

Structured put warrants, on the other hand, give investors the option to sell the underlying stocks at a set exercise price within a specified time frame. Puts are bear market tools.

It is worth noting that structured warrants are on a cash-settlement basis: At the expiry date, if the warrants are worth something (in the money), holders will receive a cash profit. However, if the warrants are worthless (out of the money), the holders’ total investment sum will be considered a total loss.

The first single-stock put warrant in the local bourse was sold in January 2020, issued by Kenanga Investment Bank on Datasonic Group Bhd. This was followed by a handful of other puts — on CIMB Group Holdings Bhd, Genting Malaysia Bhd, S P Setia Bhd, MyEG Services Bhd, Supermax Corp Bhd and Top Glove Corp Bhd — all of which were issued between May and June by Maybank Investment Bank.

But none has generated the trading volumes of the puts on Supermax and Top Glove, not by a long shot. Specifically, TopGlove-HA was the most traded security on Bursa last Monday (July 13), with 613.47 million units changing hands, whereas Supermax-HB was the third-most-traded counter, with 567.9 million units done.

The prices of the two derivatives rocketed more than 200%. TopGlove-HA soared 207% and Supermax-HB, 291%, the day the two underlying stocks climbed to their all-time highs. The mother share of Supermax saw its biggest-ever share price leap of RM2.36, to RM15.98, while Top Glove’s share price gained RM2.08, or 9.5%, to RM24.

This is clearly not rational.

The surge in prices and volumes for the call warrants is to be expected — mirroring the strong gains in the mother shares. But why would anyone chase the put warrants?

Some have pointed out that retail investors are chasing anything glove-related and, seeing put warrant prices trading at a fraction of the mother share’s price, they may have thought they had found good bargains, but clearly this is not the case.

Options are useful as hedging instruments. A put option or warrant is a bear market tool because it gives you the option of selling the underlying share at a fixed price, thereby putting a floor on losses, while holding the mother share itself offers unlimited upside.

But a closer look at the terms for the Top Glove and Supermax put warrants will show that they are so onerous that they are almost useless for hedging purposes. For example, at the issue price of 15 sen for the two put warrants, the share price for Top Glove would have to collapse to RM4.50 for investors to just break even on TopGlove-HA, a 77% drop from its current price, while that for Supermax would require the mother share to fall to RM2, or 87%, from prevailing prices, just to break even on Supermax-HB.

Note that the huge price collapse has to happen by Feb 26, 2021. What is the probability of this happening?

Prices for Top Glove’s put warrants traded as high as 30.5 sen apiece on July 13. This means some investors paid RM15.25 (after taking into account the conversion rate) for the option to sell one underlying stock at RM12 in six months. Ditto for Supermax’s put warrants, which rose as high as 35 sen on the same day — meaning some paid RM7 for the option to sell at RM5. Should investors hold on to these put warrants until the expiry date, they would never make any money.

This tells us that those who are chasing these put warrants do not understand what they are buying. Or they do not have complete information on these puts.

Unlike a stock, these warrants are on a cash-settlement basis and have expiry dates — in just six months’ time — after which the value is zero. Are investors aware that they stand to lose everything on these put warrants?

Incidentally, Maybank Investment Bank has two call warrants for Top Glove and three call warrants for Supermax, all expiring on the same date, Feb 26. Thanks to the price surges for all glove stocks, all the call warrant issuances are currently deep in the money, meaning the issuers stand to lose a big sum if they had not hedged their position. As such, it may have made sense for Maybank to sell the put options, as part of its hedging strategy.

Among market observers, the question being asked is whether the issuer and regulators have a responsibility to ensure that retail investors are fully informed.

“Regulators have to know that such trading instruments are clearly not suitable for retail investors and will encourage speculative behaviour, which could affect the development of a healthy capital market. Sound capital markets should always take into account investor protection,” an investor comments.

While some market observers say the surge in interest in the put warrants could be attributed to the increasing number of bears in the market, some say it may make more sense if the regulators were to bring back short-selling to account for a rebalancing of market pricing dynamics, instead of introducing put warrants, which are leveraged and complicated, to uninformed retail investors.

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