Tuesday, 23 January 2018

PROFITING FROM JACK MA'S FACE WITH CALL WARRANTS


I trade call warrants most of the time. But my approach can seem paradoxical at first : I focus on fundamental analysis (long term prospects of a solid business) but I'd trade the company's call warrants (short term tenure and prone to volatility).

Simply put, these are cash instruments that mirror the price activity of a stock. It moves where the underlying stock moves. You can buy call warrants cheaply and make more money - quicker.


Because of this, speculators and gamblers love trading call warrants, but they are merely looking at them from a punter's perspective.

I don't gamble; I trade warrants out of necessity. It allows me to deploy a smaller amount of capital, yet I can still achieve my profit goals. The tenure of a call warrant is fairly short (seven to eight months at most before expiration), so I can concentrate on the fundamental prospects of the company over a period lasting three financial quarters at most.


This concentration also enables me to view a company in different ways. What is its earnings prospect over this period? How will the market anticipate this? Are there external factors that are boosting sentiment in the stock? And of course, how is the stock behaving right now?


Note the highlighted parts - excluding the earnings prospect, these factors are actually finite in their relevance, even though a lot of long term value investors look at the same variables. Earnings prospects can sour this time next year, and sentiment is never a one way street. Trends always die down, but you can use them to support your existing beliefs on the company's positive fundamentals.


The problem with the fundamentals-backed buy-and-hold approach is that you have no clue how long it takes for you to be proven right. Your opportunity costs will be severe, while inflation and currency depreciation risks can easily slash the real value of your stock holdings over time. My point is that fundamental analysis can also be used in a trading (or non-long-term) context, hence the use of call warrants. 


Put them together - fundamental analysis backed by good price activity and the right theme - and your single stock pick can do ridiculous things : it can increase 50% in a quarter, it can stay up while the FBM KLCI collapses, and it can deliver a five figure net profit for your accounts.


Here's a real life example of how this works:


1) Anticipate the thematic play : This provocative pic is the kind of theme that will really arouse the punters. It adds a little boost to POS (the dominant parcel delivery player) and GDEX (a competitor that is partly owned by Alibaba) which have been demonstrating solid e-commerce business growth anyway, even if one of them, GDEX, was trading at a ridiculous PE multiple.

'Anticipate' is the key word here : getting in early was pivotal in realising solid gains. The latecomers will then bring up these stocks for you.

The best time to enter this trade was in early March, just before Ma declared Malaysia as Alibaba's regional distribution hub on March 23. The thematic play is in place and as you'll see below, the share prices of the logistics players have begun to move.

Simple newsflow analysis plays a big part in this trade. On March 17, Reuters were among the first to break the news of Ma's impending plans. His travel schedule and visit to Malaysia was also well-publicised ahead of time; Google's your best friend.  

This whole thing was a payoff from the first big clue that was reported back in November 2016 : that Ma was appointed as an advisor to the Malaysian government on digital economy matters. What else did you think was going to happen?*




All these latecomers and punters : it's not just auntie and uncle investors. It shouldn't come as a surprise, but the EPFs and KWAPs of this world played a big part in this rally. Expect a great degree of institutional trading activity when it comes to large cap stocks. If in doubt, just check Bursa Malaysia company filings.


2) Make sure the volume and price activity fits the theme : No Bollinger Bands or moving averages here. I wouldn't call the above technical analysis. It's just the realisation that the current story is enough to propel the stocks to new heights. Note that the KLCI broke a two-year high in March and the broader markets were exuberant; that certainly helped.

3) Execution stage : this particular trade lasted two months with a mid-May deadline. The right time to dispose is a variation of 'sell on news' : once all the information becomes available, the stock price will normalise. When the price activity stutters (and this was about a month after the news), it is time to get out. Setting predetermined exit points would also help.

This is how it turned out:



RGL = realised gain or loss, expressed in monetary and percentage terms. These are net gain figures, or actual ROI.


In hindsight, it seemed that Jack Ma was the most important catalyst - since May, the share prices for these two companies have stagnated, even though their e-commerce parcel delivery revenues easily outpaced other sub-segments.

This also coincided with the two companies' quarterly financials in May - while there was good growth, the financial realities and capital constraints of the logistics business don't justify a continuing rally in the shares.

I have to emphasise that I believe these stocks are solid long term purchases anyway (although GDEX's valuation might dip in a market crisis scenario). Good stocks can be traded in many different ways; this is just how I achieve my target of getting the most returns out of a relatively small capital outlay at reasonable odds. Given the prevailing market, sector and stock characteristics at the time, the risk-reward ratio was excellent.

I'll demonstrate in future columns that the same strategy can be utilised repeatedly with call warrants. I wish I can say that these opportunities crop up all the time : they only occur several times a year, but when they do, it's important to be ready.

Establishing a time period for the trade to work out is the key. It provides clarity in your investment decisions and the deadline takes ego out of the equation - if you're wrong, it's your fault. Value investors can sometimes be self-righteous and far too confident in their predictive abilities, but a trader can't afford such luxuries.

Given the short term tenure of warrants, you have a concrete deadline for your ideas to work out. Your payoff (capital gain) is directly tied to your the quality of your analysis. You're not leveraging your capital (you can't use a margin account to purchase call warrants. It's your own cash pile, all the time) but you are leveraging the warrant's profit generation capabilities. As a proxy to good companies whose stock prices can be very expensive, you'll have access to the very best companies on Bursa Malaysia with these warrants.

Most importantly, it is the best way to derive gains of 15% (from a single trade) or more with a relatively small capital outlay. Of course, you can lose 15% as well, but there are so many risk mitigation tools to prevent this (stop-losses, time-stops, and other mind-numbing terms which I will not go into right now). With the right analysis and approach, you can tip the risk-reward ratio in your favour.

And for those that are just starting out with limited funds, warrants allows you to express our ideas more cheaply. Not everybody can accumulate a large amount of Tenaga Nasional Bhd stock, but you can express your view via their call warrants at a fraction of the price.

When I started actively trading five years ago, I saw warrants as a tool for learning and I still do. You learn how to trade, you learn what it takes to achieve outsized gains, and you learn the hell out of capital allocation. It's a transferable skill set - if and when you have millions of ringgit to burn one day, just buy good old stocks.



Needless to say, it was madness. But it's an indicator of how powerful the theme was.



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