-- Posted Friday, 6 August 2010 | | Source: GoldSeek.com
** Pennaluna Prospector Newsletter – Coeur d’Alene, Idaho – August 2010 **
By Timothy Major and Tom Wobker
Although the precious metals market is taking a breather, a number of U.S. investors remain fired up with enthusiasm for trading Canadian mining stock warrants.
This is not surprising when you consider that these warrants are so loaded with leverage to the market that their returns sometimes rocket up into the 1,000% range. Also spurring interest are relatively new financial services like PreciousMetalsWarrants.com, which have turned a spotlight on the unusual profit potential in Canadian warrants.
[Ed. Note: This discussion concerns trading Canadian warrants… as contrasted with exercising them and purchasing the underlying shares. For regulatory reasons, U.S. residents generally aren’t allowed to exercise these warrants, although they’re free to buy and sell them on the Canadian exchanges.]
While Canadian mining stock warrants can present eye-popping opportunities, like other high-potential investments they also carry their share of big risks.
One particular hazard that is easy to sidestep -- but can be disastrous to overlook -- arises from the very nature of warrants themselves.
The clock is always ticking
Unlike stocks, which theoretically can survive forever, warrants have a limited life because they’re created with expiration dates. They’re born to die.
A warrant gives you the right to buy the underlying stock at a specific price for a specific time period that ends when the warrant terminates (this is sometimes called expiry). Depending on when you buy the warrant, expiry could be years, months, or only days away.
When their life ends at expiry, warrants become instantly worthless. Hence they aren’t investments to tuck away and forget. You need to keep an eye on them or you can lose money – all the money, if they expire before you sell them.
Now, suggesting you sell your warrants before they turn worthless may strike you as pretty basic investing advice. But we’ve seen it happen. As we’ll explain, the calendar and trade settlement process sometimes conspire to trip up folks on this simple tactic, and they limp away with a loss.
If you trade Canadian warrants, Rule Number One is this: remember that the clock is always ticking. Contrary to the old Rolling Stones song, time is not on your side.
Unless the underlying stock is rising nicely, a warrant’s “time value” – the worth of its continuing exposure to the movement of the underlying security – generally declines as expiry draws nearer. And the value of every warrant always plunges to zero when it expires.
Remember your Big Three Dates
One way protect yourself from an absolute wipe out is to keep in mind the Big Three Dates for the warrants you buy:
· Expiration date
· Last possible settlement date
· Last possible trade date
There are good reasons to take note of these days.
First, recognize that order execution is only one step in your securities transaction. The trade isn’t actually a done deal until delivery and payment take place. Even in the electronic age, this requires some time.
The exchange of warrants or other securities for payment is called settlement. It generally occurs a few days after the trade, on “settlement date”. The wait allows for clearing, trade matching, and other post-trade activity that goes on behind the scenes, invisible to the customer.
At settlement, the seller’s broker delivers the security, the buyer’s broker gives payment, and the transaction closes. If the seller can’t make good delivery, the trade can’t be completed. After a warrant has expired, the seller obviously has nothing left to deliver.
T+3 and how it works
In Canada and the US, with certain exceptions for financial institutions, settlement takes place three business days after an order is executed. Business days are Monday through Friday, except holidays when the markets are closed.
This settlement cycle is called T+3 -- short for “trade date plus three business days”. It’s especially critical in the case of warrants, thanks to the ticking clock and the death sentence each carries.
The T+3 count starts on the first business day after the trade. It ends on the third business day, at which time the trade settles. Thus: Trade Date + Business Day 1 + Business Day 2 + Business Day 3 = Settlement Date.
When it comes to Canadian mining stock warrants, T+3 is not mere securities trivia. More than one investor has overlooked an expiry date, waited too long to sell… and taken a painful hit when T+3 blindsided him out of the blue.
So it’s critical to be sure the warrant you want to sell will remain alive on settlement date. And the best way to do that is to know exactly the last day you’ll be able to sell and still give good delivery.
Your Last Possible Trade Date
As a result of T+3, the Last Possible Trade Date will be three business days before the warrant expires. (Notice we said business days.)
Finding the Last Possible Trade Date is generally easy. You start with the Expiration Date, because: Expiration Date = Last Possible Settlement Date (if it’s a business day… if not, Last Possible Settlement Date becomes the next previous business day).
You count backward from the Last Possible Settlement Date. Thus: Last Possible Settlement Date = Business Day 3 – Business Day 2 – Business Day 1 =
Last Possible Trade Date.
For example, say your warrant expires on Friday, a business day. That becomes the Last Possible Settlement Date and also T+3. Thursday, the day before, is T+2. Wednesday is T+1. So Tuesday would be your Last Possible Trade Date. If you don’t sell by then, it’s too late.
Sometimes it’s trickier
But it’s not always so straightforward. Here’s a true story from last winter, when T+3 ambushed some folks who owned a popular gold mining stock warrant trading on the Toronto Stock Exchange.
These warrants had an expiration date of February 17. That was Wednesday, a business day, and thus also the Last Possible Settlement Date.
Surprisingly, however, the last day owners could sell and still give good delivery at settlement was Thursday, February 11. This caught some people flatfooted because it was fully six calendar days before expiry. At first glance, this seems way too early to be the Last Possible Trade Date. But those who tried to sell after that quickly learned otherwise.
Here’s how the count went.
- Wednesday the 17th was Expiration Date … and since it was a business day it also became T+3, the Last Possible Settlement Date…you count backwards from there
- Tuesday the 16th was T+2
- Monday the 15th was a market holiday (Family Day in Canada) … so it wasn’t a business day and it was not counted as T+1
- Sunday and Saturday, the 14th and 13th, aren’t business days, so they weren’t counted either
- Friday the 12th, the next business day, was T+1
- Thursday the 11th was a business day and thus became T … and the Last Possible Trade Date
After the 11th, sellers couldn’t deliver good warrants at settlement. They were left with nothing but a worthless security, a tax loss, and a pricey lesson from the school of hard knocks.
Our advice
Here’s our recommendation. If and when you trade Canadian mining stock warrants -- or any warrants, for that matter -- don’t play chicken with expiry. Figure out your Big Three Dates at least a couple of months before expiration.
Double check to be certain you’ve used actual business days to calculate last possible trade and settlement dates. Watch for Canadian market holidays, because they aren’t always the same as in the States. After you’ve found those dates, write them down and keep an eye on them.
Finally, leave yourself a little breathing room; don’t wait until the very last minute to trade.
For more information about Canadian stock warrants, try these sites:
http://www.preciousmetalswarrants.com
http://canadianwarrants.com/index.html
If you have an insatiable desire to learn more about T+3, see these pages on the SEC website:
http://www.sec.gov/answers/tplus3.htm
http://www.sec.gov/investor/pubs/tplus3.htm
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The authors -- Timothy Major, an Idaho native, holds a degree in commerce from the University of the Witwatersrand in Johannesburg, South Africa. For 15 years he has been a broker with Pennaluna & Company, a FINRA broker-dealer and market maker with its main office in Coeur d’Alene, Idaho. Tom Wobker holds degrees in journalism and law and is a principal with the firm. Founded in 1926, Pennaluna trades stocks on all U.S. and Canadian exchanges, Nasdaq, OTCBB and Pink Sheets. Phone 800-535-5329 or visit www.pennaluna.com or for online trading www.penntrade.com.
-- Posted Friday, 6 August 2010 | Digg This Article
| Source: GoldSeek.com
