re: warrants are for suckers - must read
Minotaur now posts on #trade. Has been there for about 8 months now.
Warrants are for mugs.
It is often said that warrants are more expensive because they carry a "liquidity premium". Most people interpret this to mean a better spread. This is incorrect. In 90% of cases, the spread on a warrant is the same or worse than on the equivalent ETO. Lets take a fictional warrant, say a $10 apr call 4:1 with spread 12/14. Now the ETO, spread 46/52. Which seems worse? The ETO right? WRONG. While the spread here is 6c, it is actually a better spread than the warrant. Lets trade them now. Assume no stock movement.
We buy the warrant at 14, then sell it back at 12. We have lost 14.28% of our capital.
Now the ETO.
We buy at 52, sell at 46. We have lost 11.5% of our capital.
Which would you rather lose?
Why is this? Most people forget the conversion ratio when thinking about the spread. The warrant has a 2c spread, but when we take into account the 4:1 conversion, it is actually an 8c spread. But it gets worse. If we multiply the 14c ask by 4, we get 56. The ETO ask is only 52. Theres another 4c or 7.7% we are throwing away. Liquidity premium you say? HA!
What is liquidity premium? Obviously it is not a better spread, as I have proven. Volume perhaps? Lets see. Most warrants have a 50k spread. But whats that converted to options? 50,000 / 4 = 12,500 shares, or 12.5 contracts. Eh? Most options have spread volumes of at least 20 contracts, ie 80k warrants. Liquidity premium? HA!
But wait, theres still more. Lets say you are a big trader in warrants. You want to buy 200k. You put in an order to buy 200k at 14. The market maker hits you for 50k at 14, then puts in a new offer for 50k at 14.5. You are angry, but hit at 14.5 anyway. He hits you for 50k, then puts in offer of 15. Are we catching on yet? This is what happens in warrants.
Now if you wanted to do the same in options, its a lot more fair. 200k warrants is 50 contracts. If you put in a bid of 50 at 52, you will be filled for 20 at 50, then after a minute the spread will reset, and you will be filled for 20 more, and so on.
But wait, theres STILL more.
Market makers in warrants are blood-thirsty so-and-so's. If the see a heap of amatuer traders buying a warrant, they will increase the spread to rip them off. Say 13/15. They try to justify this by giving the excuse "volatility increase". Then later, when all the traders want out, they drop the spread, again using the excuse "volatility decrease". Say 11/13.
Now if you still want to trade warrants after all that......lol
