The warrants market underwent several sea changes last year but by early 2002 it had carved itself a position in the local equity market with average daily turnover regularly exceeding R50m. The market is still coming of age, though.
First, it hasn't yet stabilised: the number of warrant issuers grew from four to seven last year and there's talk that two more international banks are about to enter the fray. So many warrants have been listed on the JSE Securities Exchange, people stopped counting after 500.
Second, the market is still developing sophisticated instruments. Issuers experimented with different types of exotic warrants, some of which were greeted enthusiastically while others proved to be too sophisticated or not suited to the local investors or the market conditions.
The issuers are also building their comparative advantages. Gensec captured the demand for index warrants with various Satrix issues. In mid-2001, it issued compound warrants for investors looking for extra-high gearing during volatile and uncertain market conditions and, for a few months, these issues dominated the action.
But they expired out of the money in late March after equity markets did an about-turn at the end of 2001 .
SCMB warrants marketing and sales head Brett Duncan says interest in these instruments "has faded for now" because the Satrix compound warrants, of which the compound put was most popular, expired worthless. This was a call on a put, that is, a negative view on the market.
BNP Paribas warrants marketing and sales head Deon Strydom says trade in index warrants is normally dominated by professional investors who trade in the index because it is easier to read and the All Share index is full of rand hedges.
"When the markets are volatile, a lot more people move into index warrants," he says. "The compound warrants made a lot of money, then lost a lot of money because markets were not as volatile when they expired."
Société Générale warrants marketing and sales head Richard Swain says many people backed off trading in complex warrants when volatility in the equity market tapered off. He says the market is "very new and evolving and doesn't need too many exotic warrants". Investors need to learn how to trade "vanilla" warrants and then branch out, he says.
What started as a promising year for put warrants (an option to sell the underlying share) ended up being costly for bearish investors . Instead of tanking, international and local equity markets rebounded.
But the wide variety of put warrants that were issued last year did add to the diversity of the warrant sector and gave investors more flexibility to take advantage of different types of market conditions, giving the warrant market's additional depth.
Issuers have come under criticism for making ad hoc adjustments to the measured volatility of warrants. A rise in volatility (the only factor in the warrant pricing equation that the issuer can change) increases the price of puts and calls and a decline reduces their price.
An SCMB warrants spokesman says volatility is less of an issue now because overall market volatility has fallen from the peak it reached after September 11.
Swain says issuers are not able to offer investors leverage if they cannot adjust the volatility, but adjustments " are made as gradually and sensitively as possible".
Perhaps the most significant change in the warrants sector during the past year, however, was the complete about-turn in the sectors that attracted the most action in early 2001 compared with those that topped the rankings early this year.
Duncan says IT stocks were all the rage this time last year and the mainstay of the market, but this year there has been a firm shift into resources warrants. "Resources have done well for retail investors," he says. "They have come around so many times that there have been many opportunities to get in."
The action has been focused on Sasol, platinum stocks and gold, where investors "have been far more willing to take a punt and have been rewarded".
Strydom points out that of the 10 best-performing warrants during the year to end-March, more than half were resources warrants. The top warrant was a Standard Bank Implats call that delivered 2 192% growth from when it was issued in May last year. Iscor and Gold Fields also gained strongly over the period.
Interestingly, there wasn't a put in the top 30 warrants, whereas a year ago investors were making their money in Didata and Investec puts.
Warrant issuers are rushing to offer new gold warrants to meet soaring investor appetite for them. Standard Bank issued 12 new warrants in mid-February, of which five were gold warrants.
Duncan says there's a feeling that gold may be coming out of a 10-year stagnation and that this view has culminated in the doubling in price in some of the gold warrants. "There's great interest from foreigners," he adds. "Investors are playing catch-up."
Strydom believes gold is the "big story of the year" because the precious metal's price has stabilised at US5 intervals and climbed steadily. "It usually spikes and comes back," he says.
The BNP Paribas house view of the gold price at $285-295/oz for 2002 is less optimistic than some other forecasts that see its value climbing well above the $300 level.
There's a heated debate about whether the financial sector is about to take over from resources as the top performer in warrants.
Strydom says there could be action in bank warrants because "all other sectors are overbought". Though the sector has experienced knocks because of Unifer, Regal and Saambou, there are investors who believe it has taken its pain. "There's a growing interest in banks because resources have run so hard." But he does admit that a weaker rand and higher interest rates are not good for bank valuations .
SG's Swain expects financials to continue to underperform because consumer inflation is forecast to peak at 9,2% by June. "There's still scope for further inflationary pressure and that is not good for banking ."
Duncan says there was interest in financials in January, but with the increase in interest rates investors shied away . "They feel they are undervalued but that it is not the right time to buy. Because they are a short-term trading instrument, investors will wait for it to happen rather than pre-empt an increase in the financial sector."
Swain says it could be a year for industrials and suggests investors look at Murray & Roberts, Aveng and Barloworld. "We have just issued warrants on Barloworld, Steinhoff and Nampak."
Duncan expects a year of consolidation and levelling off in the warrants market. "Warrants have become an integral part of the JSE and have found their place, but you won't see a doubling in volumes like last year."
He says many investors are using warrants to hedge their portfolio because of the tax implications of trading too actively. Warrants also give investors more flexibility and downside protection during uncertain market conditions.
Strydom agrees that growth in the warrants market won't be as impressive as its doubling since 2000, driven by investors joining the market. But he still expects 20% growth this year.