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Monday, 12 March 2018

WANT TO TRADE BURSA MALAYSIA CALL WARRANTS? HERE'S A GUIDE AND CHECKLIST

There are hundreds of call warrants on Bursa Malaysia now. Even if you're the most sensible value investor in the country with as much personality as a dry wall, you should still have a look at them as a viable way to express your market views. Call warrants are many things, but they do not exclusively belong to speculators and those with an inclination to get poor quick (although most of the time that's what happens to speculators).


To mitigate the odds of making mistakes - you will make them, but hopefully under very strict parameters - you'll need a guide. Trading warrants is more than just about following the herd. You can be reactive (following the herd) as well as proactive (letting the herd follow you).


Contrary to popular belief, call warrants are usually issued to highly reputable and highly profitable companies. They can be a speculative instrument, but they shouldn't be compared to penny stocks where syndicates are just waiting to tempt you into parting with your money.



 When searching for call warrants in the wild, bring binoculars. Image link.


In this post I will share that guide. It's a list of important parameters and characteristics and broadly covers three things:


1) The call warrant identification stage (choosing the best one).


2) The 'mother share' fundamentals filter (things to watch out for when identifying a company to trade. This is supposed to complement your number crunching and typical fundamental analysis activities).


3) Managing the trade (this is about setting parameters. You have to control the trade, or the market will do it on your behalf with terrible results).


CALL WARRANTS ARE A FILTER FOR GOOD COMPANIES


I like call warrants as they tend to be a filter of the best companies (to trade) on Bursa Malaysia right now. Investment banks that issue these things have to be choosy when it comes to picking a company to attach their call warrants to. Among the criteria for issuing call warrants, as far as I know, are as follows:


1) The company must have an average market cap of above RM1 billion over a period of three months. This is especially important for small/mid cap companies whose market value has just exceeded that mark (this was why HIBISCUS warrants had just been released in the market).


Incidentally, having new call warrants mark these companies as a serious player in the market. They've hit that RM1 billion mark and they stand a chance of maintaining that mid-cap classification, which then allows institutional funds with such a mandate to buy into them. Obviously that would be very supportive of price and momentum.


2) There must be substantial trading interest in the company or sector. I've covered this before with the oil and gas downstream sector, where PETRON started getting attention as soon as they recorded decent quarterly earnings. The IBs issued HENGYUAN call warrants as soon as they could, and look how far we have come over the past 9 months!


3) It must be reasonably easy for the IB to conduct market making activities and to hedge its exposure to the call warrant's underlying stock. Market making means the automated buy and sell queues that you see in the warrant every day : the spreads must be tight and they must reasonably reflect real prices; otherwise nobody will trade the call warrant. Note that IBs typically do not take a directional position associated with the call warrant; they only hedge.


4) It most likely reflects the market's prevailing biases. Hey, it's supply and demand. I offer a product that I think you will buy and make me profitable. That's why everybody's issuing HENGYUAN call warrants. Everybody and their grandmother has an opinion on Proton now; that's why DRB-HICOM is so popular. If you can think of a stock that's arguably getting 'hot', rest assured there is (or will be) a call warrant to trade. It's a natural filter for good companies and good stocks.


If you're new to call warrants here's a crash course before we get into the details:




THE TRADING GUIDE AND CHECKLIST


Note : A checked item does not necessarily mean it is good for trading. It's just the little things to care about when you're looking for a good call warrant. I've included my personal preferences as a rough guide; e-mail me if you want the printer-friendly version.




SECTION ONE : THE CALL WARRANT IDENTIFICATION STAGE

  • (  ) Is it one of the first call warrants to be issued for this presumably promising company? 

  • (  ) Is the mother share priced at RM3 and above? (Stocks above this price point exhibit more volatile characteristics, which makes it good for expressing a short term viewpoint)

  • (  ) Is the call warrant less than a month old? (Good if it is. There's a chance the call warrant is undervalued due to lack of interest. This is important if you're accumulating a position before the stock rallies)

For the following items, read my previous post. It explains why I look at these traits.

  •  (  ) In terms of liquidity, volume and price, is it the best call warrant available?

  • (  ) Was there a previous disconnect between the call warrant and the mother share due to some short term event? (Better if there was none)

  • (  ) Is the call warrant cheap in absolute terms? (My definition is typically anywhere between 9 sen and 19 sen. It's cheap enough to accumulate a large position and attractive enough to entice the herd) 

  • (  ) Has the warrant undergone a slump due to a recent weakness in the mother share price? (Better if there was none. An easy example is the usual post-earnings decline for strong momentum stocks. Even if the earnings were fantastic, there is a better-than-average likelihood of profit taking at this point. This can seriously hurt the call warrant's value, of course)

  • (  ) Has there been a share split/revaluation exercise in the mother share during the call warrant's tenure? (I will not trade a call warrant that references a stock's pre-split exercise price/breakeven values. The valuation is no longer precise; the warrant is simply reduced to a pure speculative instrument. An example of this was the recent spinoff of SIME)


SECTION TWO : THE MOTHER SHARE FILTER

 Take good care of your call warrant.


  • (  ) Is this the best company in its sector? (This typically means that its shares tend to outperform its peers. An example is TOPGLOVE - it is by far the sector beating glovemaker)

  • (  ) Is the sector within your sphere of competence? (No matter how good you think you are, you're never going to know all the sectors all the time. Stick to what you know best; perhaps a sector in which you've repeatedly demonstrated an ability to make profitable investments from fundamental analysis)

  • (  ) Are the dynamics of the sector easily understood? (The earnings prospects of glovemakers, manufacturers are relatively easier to analyse from a short-to-medium term perspective. Conglomerates, tech - not so much)

  • (  ) Presumably the stock has a catalyst. Can you attach some solid, actual figures to it? ('Company A to bag jobs from a Jibby infra project this year' isn't good enough. It has to be 'Company A to bag RM500 million worth of jobs this year') 

  • (  ) Is this sector beating the broader market? (Very important. It means the company will outperform during good times. During the bad times, assuming the catalyst is intact, the company will not decline as much as the KLCI itself)

  • (  ) Would this sector story/theme last beyond a single quarter? (Better to identify long term themes. An example is the recovery in the refineries segment last year)

  • (  ) IS THE STOCK FLIRTING WITH A PRICE BREAKOUT SOON? (Very important. It's a gauge of the existing enthusiasm in the stock)

  • (  ) Market beating profit margins? (This must not be hard to explain or a result of one-off gains. It must be fundamentally backed) 

  • (  ) Market beating revenue growth? (Relative to sector peers and the broader market)

  • (  ) Net asset value (NAV) growth on a year-on-year basis? (This shows that the company's earnings performance was not diluted from rights issues, for example. Long term growth supports the case of long term momentum for a really good company)

  • (  ) Is it nearing a dividend or rights ex-date of some sort? (This may mean that the recent momentum is because of some interest in shares acquisition before the ex date; it's not a good sign since the trade is supposed to be fundamentals oriented)

  • (  ) Is it a stock in a previously unfancied sector? (Higher upside potential with the earnings recovery theme)

  • (  ) Is it a contrarian or conventional pick? (Contrarian picks offer higher upside potential but you may have to wait longer, leaving your call warrant vulnerable to time decay)

  • (  ) Is it gaining momentum pre-earnings or consolidating/gaining new momentum post-earnings? (Important to factor in the short term cyclical nature of momentum stocks) 

  • (  ) What is the MAJOR SHIFT that could propel the company to greatness? (Always better to list down and properly articulate what the catalysts are)

  • (  ) Is the stock clearly undervalued by most fundamental measures? (Good if it is. But it's also important to have the right call warrant) 


SECTION THREE :  MANAGING THE TRADE ONCE IT HAS BEEN MADE


  • (  ) It's been a few days/weeks. Is the stock still trading within 5% of its recent high? (This is a gauge of whether the trading interest in the stock is sustained)

  • (  ) Is there a sensible time loss or stop loss for capital preservation purposes? (Always have these and follow them strictly; no room for flexibility if you want to avoid severe losses)

  • (  ) Was the position fully accumulated at the start or is there room to build up on it? (This is an indicator of confidence at the start of the trade. Never acquire more shares when the position is showing a loss)

  • (  ) Can you withstand a 1.5-2 months' slump in the stock price? (No big deal if you just buy the stock itself. But if you buy call warrants, this can be fatal. This is a variation of the time stop)

  • (  ) Is there another call warrant which is exhibiting better characteristics? (This implies that your original choice was wrong. Some call warrants outperform others based on volume and trading activity alone. If yours is seeing little trading interest and performs worse than other call warrants of the same stock, that's a warning sign)

  • (  ) What is the deadline for this trade to show profitability? (You can be right and still lose money if your timing is wrong. The stock can be undervalued longer than you can remain solvent. If you're not profitable by this date which you have, then your trading thesis is wrong. Ditch your ego and take your losses) 

  • (  ) Have you missed an opportunity to take profits? (Call warrants can be volatile by nature. If your paper profits completely evaporate, don't try to hope for a recovery in prices. Acknowledge your mistake and sell the position. The paper profit essentially validates your trading thesis. When it's gone, you're no longer operating within the same parameters)

And that's it. Try to think rationally and always detach your ego from the trade. Know your limitations and don't waste time things you can't control. Keep the decision making to yourself; never let the market do it for you.