Time Value of Inline Warrants
Mr Chin02/08/2019
While warrants are like fashionable items that will depreciate with time, inline warrants are a completely different type of structured product.
Theoretically, the time value of a warrant would decline over time and reduce to zero upon expiry, this erosion of time value is called time decay. The price of a warrant reflects the probability that it will be exercised on the expiry date. Warrants with longer maturity will have a higher time value as they are more likely to become in-the-money and be exercised. Time decay measures the probability that a warrant will become in-the-money and be exercised, and it will decline as the expiry date approaches. In order to avoid time decay, investors seldom hold their warrants until maturity.
However, the idea of time decay does not apply to inline warrants. In fact, inline warrants may exhibit a positive time value. If the underlying price falls within the upper and lower strikes, the time value will increase to reflect the decreasing probability that the inline warrant will become out-of-the-range over time. Hence, holding inline warrants for a longer period of time is not a bad idea.
But investors should consider whether the inline warrants are in-the-range or out-of-the-range when choosing between warrants with a later expiry date and those expiring soon. Out-of-the-range inline warrants with longer maturity would be more favourable since there will be more time for the warrants to get back within the range.
While inline warrants and warrants are both structured products, their structure, mechanisms and pricing factors are different. Therefore, we cannot apply the same rules as warrants when looking at inline warrants.