DW stands for Derivative Warrant – an essential tool for traders to know

DW stands for Derivative Warrant, a widely accepted derivative instrument in the financial markets. Currently, this product is gaining increasing interest from traders due to the opportunity for quick profits. However, DW is also a high-risk tool that requires solid fundamental knowledge.

Basic Understanding of Derivative Warrants (DW)

What is DW Really?

DW stands for Derivative Warrant, which grants the right to buy or sell an asset at a predetermined price and conditions. Investors can use this instrument to speculate on price movements of the underlying asset, which could be stocks, indices, or other financial instruments.

The basic operation of DW is that when an investor buys and holds a DW until its expiration date, they profit or incur losses based on the price difference. However, this method is less popular because it takes time and suffers from time decay, which decreases value daily.

The most popular method is speculative trading, especially short-term day trading, because DW responds quickly to changes in the underlying asset’s price. Using leverage allows traders to profit from small price fluctuations with relatively little capital.

Types of DW That Traders Need to Distinguish

Call DW moves in the same direction as the underlying asset’s price. When the underlying stock price rises, the Call DW also increases, making it suitable for bullish markets.

Put DW moves in the opposite direction to the underlying asset’s price. When the stock price falls, the Put DW increases, suitable for bearish markets.

Besides the rights-based classification, DW can also be categorized based on the underlying asset into three types:

• DW referencing Thai stocks (limited to SET50 and SET100)
• DW referencing Thai stock indices (usually based on SET50)
• DW referencing foreign indices (e.g., DJI USA, HSI Hong Kong)

How to Read and Understand DW Codes

Long and complex DW codes like SET5001C0921A follow a standard format: UUUU – II – C/P – YYMM – S, where each part means:

• UUUU = Underlying asset code (e.g., SET50, PTTE, AOT)
• II = Issuer code (e.g., 01 = Bualuang, 28 = Macquarie)
• C/P = Type (C = Call, P = Put)
• YYMM = Expiration year and month
• S = DW series/model

For example, SET5001C0921A means: A DW referencing SET50, issued by Bualuang, Call type, expiring September 2021, series A.

How to Calculate and Factors Affecting DW Price

Basic Formula for DW Price

DW Price = Intrinsic Value + Time Value

Intrinsic Value is calculated as:

• Call DW: (Underlying Price – Strike Price) × Conversion Ratio
• Put DW: (Strike Price – Underlying Price) × Conversion Ratio

Time Value depends on the remaining time; the longer until expiration, the higher the time value. As expiration approaches, this value diminishes.

Example: PTT01C0921A has a DW price of 0.65 THB, strike price 27 THB, conversion ratio 10:1, and current PTT stock price 31.5 THB:

Intrinsic value = (31.5 – 27) × 0.1 = 0.45 THB

The remaining 0.20 THB is the time value, which will disappear if held until expiration with no change in the stock price.

Key Factors Influencing DW Price

1. Underlying Asset Price
The primary driver of DW price. Call DW increases as the underlying asset’s price rises; Put DW increases as it falls.

2. Remaining Time
Longer remaining time means higher value due to time value. As time passes, both Call and Put DW tend to decrease.

3. Volatility (Volatility)
Higher volatility of the underlying asset increases the prices of both Call and Put DWs, as the chance of profitable moves is greater.

Strategies for Choosing and Risk Assessment

Factors When Selecting DW for Trading

Effective Gearing
Indicates how much the DW price will change relative to the underlying asset. For example, a gearing of 7x means if the underlying moves 1%, the DW will move approximately 7%, in profit or loss. Traders should choose DWs with gearing aligned to their risk appetite.

Time Decay
The decline in DW price over time when the underlying remains unchanged. Lower time decay is preferable. Short-term trading near expiration is common because of higher time decay.

Implied Volatility
Represents the market’s expectation of future volatility. DWs with lower implied volatility are generally cheaper. Selecting DWs with the lowest implied volatility can be advantageous.

Liquidity
High liquidity ensures ease of buying and selling without significant price impact. It helps the DW price track the underlying asset accurately.

Bid-Ask Spread from Market Makers
Sometimes, actual traded prices may deviate from theoretical values due to low liquidity or system issues. Regularly check buy-back prices from market makers to ensure fair valuation.

Opportunities and Risks in DW Investment

Why Traders Are Interested in DW

DW offers several advantages:

• Low Initial Cost: DW prices are often just a few satang to a few baht, traded in lots of 100 units, making it accessible for retail investors.
• High Leverage: Small investments can yield multiple times returns.
• Market Flexibility: Call DW for bullish markets, Put DW for bearish markets, enabling profit in all conditions.
• Limited Losses: Maximum loss is limited to the invested capital; no negative balance.
• Versatility: Suitable for short-term speculation and hedging.

Risks Traders Must Face

• High Volatility: DW prices can change faster than the underlying asset, amplified by leverage, increasing both profit potential and risk.
• Time Decay: DWs lose value daily, even if the underlying doesn’t move.
• Expiration Date: If DW is Out of the Money at expiration, the investment becomes worthless, regardless of prior market value.
• Liquidity Risk: During abnormal market conditions, DW liquidity can dry up, causing prices to deviate from fair value.

Comparing DW with Other Financial Instruments

DW vs Warrant vs Option vs CFD

All are derivatives but differ significantly:

Warrant: Issued directly by listed companies, with fixed expiration and strike prices. Price calculated as: Stock Price – Strike Price × Exercise Ratio. No leverage.

Option: Contract between buyer and seller with agreed premium; traded on TFEX. Buyer pays premium; seller receives it.

DW: Issued by commercial banks, uses leverage, with price based on intrinsic and time value, traded on SET.

CFD: Contract for difference, allowing traders to close positions at will, with no expiration date, covering various assets like foreign stocks, indices, forex, commodities.

When Is DW Suitable for You?

Choose DW if:

• Interested in Thai stocks or indices
• Focused on short-term trading (days to weeks)
• Want to trade alongside regular stocks in one account

Choose CFD if:

• Want to trade foreign stocks or indices
• Prefer no fixed expiration
• Seek diverse assets (Forex, commodities, crypto)

Key Terms and FAQs for DW Traders

Important Vocabulary

• Underlying Asset: The asset DW references (e.g., SET50, AOT stock)
• Strike Price: Price at which the right to buy/sell is exercised
• Conversion Ratio: DW to underlying asset ratio (e.g., 10:1)
• Days to Last Trading: Last trading day for DW
• Sensitivity (Delta): How much DW price changes with 1-unit change in underlying
• Time Decay: Daily decrease in DW value due to time passing
• ATM (At-the-Money): Underlying price equals strike price
• ITM (In-the-Money): Exercising yields profit
• OTM (Out-of-the-Money): Exercising yields loss
• Implied Volatility: Market’s forecast of future volatility
• Delta: Rate of change of DW price relative to underlying
• Effective Gearing: Leverage ratio of DW
• Last Trading Date: Final day to trade DW
• Expire Date/Maturity Date: Date of exercising rights
• Outstanding: Number of DW units held
• Historical Volatility: Past volatility of underlying asset

Common Questions

Is the last trading day different from the expiration date?
Yes. Last trading day is the final day to buy/sell DW; expiration date is when rights are automatically exercised or expire.

How does DW differ from Warrant?
DW is issued by banks, uses leverage, and has time decay. Warrant is issued by companies, no leverage, no time decay.

What does a 7x gearing mean?
If the underlying moves 1%, DW moves approximately 7%, magnifying gains or losses.

Why be cautious of time decay?
Because even if the underlying doesn’t move, DWs lose 1-5% of value daily, eroding investment if held long-term.

With this comprehensive understanding, traders can approach DW markets confidently, managing risks effectively. DW, as a derivative instrument, is suitable for those with sufficient knowledge and risk tolerance.