The strategies


Warrants can be used as part of a wide range of investment strategies to satisfy an investor’s expectations and objectives,. They can serve very conservative purposes, such as the hedging of an existing portfolio, or they can be used aggressively to speculate on the upside or downside of the underlying asset. Even a conservative portfolio can make use of warrants to boost performance by investing a percentage of the capital in warrants.

90/10 strategy

Anyone interested in bumping up their portfolio could adopt the 90/10 strategy, which is based on a portfolio combining both fixed-income securities and warrants. The ratio of fixed-income securities to warrants is 90 percent to 10 percent. The idea behind this strategy is that the interest income on bonds held in the portfolio must be high enough to offset any total loss made on the warrants. An investor with TRY100, 000 in disposable capital, for example, could invest TRY 90,000 in Turkish Treasury paper with a one-year maturity and yielding 11 percent. Upon maturity, when these government bonds are redeemed, they would yield a total of 11 percent, or TRY 9,900. At the end of the year, the investor would therefore have TRY 99,900, regardless of whether or not the warrants ended in the money .If, however, the warrants were also to generate attractive price gains, the total performance of the portfolio would be far greater than if the investor had simply invested the whole TRY 100,000 in fixed-income securities.

The feasibility of this strategy does, of course, depend on the general interest rate level, i.e. the higher the risk-free return on investment grade bonds, the more worthwhile the strategy. In the event of lower interest rates, either the proportion of government bonds should be increased (e.g. a 95/5 strategy) or the investment horizon should be extended.

Long call

The most renowned strategy used on the warrant markets involves purchasing call warrants (calls) and is known in the trade as a “long call”. As such, the investor speculates on the price of the underlying rising until the expiry date of the warrant. This strategy only bears fruit if the break-even point is achieved. The price of the underlying must rise to more than the sum of the strike price plus the warrant price multiplied by the exercise ratio at the time of purchase. Transaction costs also need to be taken into account. However, most investors simply try to sell their warrant after some time for a higher price. In this case the investor makes a profit as soon as the difference between the price of sale and the price of purchase exceeds his transaction costs.

Long put

The opposite strategy, involving the purchase of put warrants (puts), is called a “long put”. Here, the investor believes that the price of the underlying is going to fall dramatically. The break-even point is achieved when the price of the underlying is less than the strike price minus the warrant price at the time of purchase, multiplied by the exercise ratio. For example, if you buy a put on a share with a strike price of TRY 100 and an exercise ratio of 1:1. Your warrant costs you TRY 10 and so the break-even point lies at TRY 90. If the share price falls even further by the time your warrant expires, you will make a profit. Transactions costs are not included in this example but also need to be taken into account.


Warrants can also serve very conservative purposes, such as the hedging of securities portfolios against looming downside. Investors with a large equity exposure, for example, and who expect prices to fall, could think about selling their positions. This, however, may not be advisable for tax or other reasons, including the high transaction costs involved in the sale and perhaps the repurchase of the shares at a later date. Ultimately, however, there is no need to sell if the investors buy puts, effectively “hedging” themselves against any downside. The theory behind this strategy is that if share prices fall, the value of the warrants will rise, thereby cancelling out any loss in value. This hedging strategy nevertheless comes at a price, namely the purchase price of the puts, which can be seen as a kind of protection premium. If the downside fails to materialise, the premium will be lost but investors can put their minds at rest.

In this instance, a distinction should be made between a static and a dynamic hedge. The static hedge is better suited as a 100 percent safeguard on the expiry date of the warrant, the dynamic hedge for the time period prior to expiry. For the former, a single calculation of what type of, as well as how many, puts are needed to hedge the portfolio is made at a specific point in time. The number remains the same, hence the term “static”. For dynamic hedges, on the other hand, the put position is regularly adjusted depending on the performance of the equity portfolio. The position is therefore considered “dynamic”.

Whereas professionals in this field, such as fund and asset managers, tend to prefer to dynamically hedge positions, static hedges are often sufficient to meet the needs of a private investor, especially as continuous adjustments can entail high transaction costs.

A portfolio is the easiest to hedge if it contains highly capitalised stocks for which puts are readily available, or if it almost mirrors a particular index for which an equally large amount of puts are available. In the cases set out above, investors can use warrants to either hedge each individual position or the entire portfolio. The more valuable the assets in the portfolio, the higher the “protection premium” will be. Another factor influencing the premium is the extent of desired “coverage”, e.g. whether investors want “all risk” or limited protection, whereby they would bear a portion of any loss incurred.

Investors wanting to hedge portfolios that more or less mirror the ISE30 Index can act as follows. Let us assume that the ISE30 Index is currently at 60,000 points and that investors fear it will nose-dive to the 50,000 mark. By acquiring a sufficient number of puts with a strike price of 60,000 points, they are fully hedged,. This method of hedging, however, does not come cheap. Puts with a strike price of 58,000 points and identical maturities are significantly less expensive than puts with strike price of 60,000. Investors buying the cheaper warrants however would have to bear a portion of the losses were the index to shed those 10,000 points. In this case, the hedge cover would only kick in if the ISE30 Index fell below the 58,000 mark. The region between 58,000 and 60,000 points therefore corresponds to the aforementioned portion borne by the investors. Of course, investors may, at a ratio of 50/50, also acquire warrants with a strike price of 58,000 and 60,000 points, or could opt to either bear an even higher portion of the incurred losses or, depending their requirements, to combine any number of possibilities. The decision is not an easy one and must be considered carefully in each individual case.Learning and Know-how