What is the difference between effective gearing and gearing?

“Gearing” means the relationship that the cost of the underlying asset bears to the cost of a warrant or a CBBC. For example, if the gearing for a particular warrant is 10 times, then the investment cost of that warrant is 1/10 of the underlying asset.

However, in the case of a warrant this only relates to the initial cost of the underlying asset and the initial cost of the warrant– it cannot be used later to reflect the dynamic relationship between the price of the underlying asset and the price of the warrant over time.

“Effective gearing” of a warrant is calculated by multiplying the gearing and the delta of the warrant.

Effective gearing is a better measure of the percentage change of a warrant with a 1% change of underlying asset. For example, if the effective gearing is 10 times for a particular call warrant (and we assume other factors remain unchanged) when the price of the underlying asset rises by 1%, the theoretical price of the call warrant price should rise by 10%. Similarly, when the underlying asset falls by 1%, the theoretical price of the call warrant price should fall by 10%. However, this should only be used as a reference; the effective gearing of a warrant will change over time as other factors, such as the underlying price, delta, gearing, time decay and implied volatility, also change.

For CBBCs, “gearing” and “effective gearing” are the same in most circumstances, which is the potential multiplying effect on the price of the CBBC in response to a 1% change in the underlying asset price.