How to hedge your long position risk of a US stock with a US stock put warrant?
There are different types of products available in the market for investors to take a bearish position. The common approaches investors choose are short selling the shares, using listed options, put warrants, or inverse ETF. Below shows a brief comparison between their pros and cons.
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Short Selling
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Listed Options
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Put Warrants
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Inverse ETF
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Pros
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- Easy to calculate PnL
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- Standardised terms, various choice of terms available
- High liquidity for highly-traded shares.
- Different gearing are available for leverage
- Long and short positions available, allowing for different trading strategies
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- Terms are defined by issuers, providing flexibility
- Generally more liquid depending on the terms and the issuer’s competitiveness
- Different gearing are available for leverage
- Loss are limited, no margin call or forced liquidation will occur
- No separate brokerage account needed
- Denominated in either HKD or USD, provide invesetor to trade more flexibly with various currencies
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- Easy to calculate PnL
- Mainly tracking major indices, liquidity is generally higher.
- Can be traded with stock brokerage account.
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Cons
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- Cost of borrowing shares may be expensive
- Some shares may have limited quantity or not available for borrowing
- At risk of significant loss, margin call, or even being liquidated by broker when the direction is opposite of the position
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- Options for some underlying may have limited liquidity and wide bid-ask spread
- A separate options account is needed to trade
- Margin requirement dependent on the position. Margin call or forced liquidation are possible.
- The loss of some option strategies may be infinite
- Implied volatility may fluctuate
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- Long positions only. Variations in trading strategies are limited
- Possible total loss when the direction is opposite of your position
- Implied volatility may fluctuate
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- Tracking error and management fee have to be considered
- Usually no leverage or only up to 2 time leverage available on HKEX.
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For US stock day-traders, US listed options may be their first choice as the volatility of US stock performance during Hong Kong hours are relatively lower compared to US regular sessions, increasing its difficulty in obtaining potential returns.
However, for investors who have a bearish view or would like to hedge their positions in short-to-medium term, US stock warrants listed on HKEX have the competitive edge such as better liquidity, low capital requirement, bridging timezone difference, providing ahead of time trading opportunites. For more information, please visit our page "Why should I invest in US Stock Warrants?".
Example – Hedging with a 5-times gearing warrant
How effective is the hedging depends on investor’s preference. If investors would like to hedge again half of their position of about $100,000 worth of Tesla shares, if they choose a Tesla put warrant with approximately 5 times effective gearing. Then about ($100,000 x 50%) / 5 = $10,000 is to be paid to purchase this put warrant.
Suppose shares of Tesla dropped by 10%, assuming other factors affecting the warrant value remains unchanged, the price of the put warrant will theoretically increase by 50%. Although investors would experience of loss of $10,000 in their position of Tesla shares, their would gain $5,000 from the warrant position, offsetting half of the loss.
