Holders of call warrants closely track the movements of the underlying stock prices, as the value of their instruments depends on the latter.

It is little wonder then that there was much hue and cry when DRB-Hicom Bhd’s share price plunged 14% or 33 sen to RM1.95 in the final minutes of trading last Monday, just five days before the structured call warrants (DRB-CE) issued by OSK Investment Bank Bhd were due to expire. The derivatives expire today.

The fact that the shares fell to RM1.95 on that day — coincidentally the strike price of the call warrants — naturally raised suspicions among investors, even if it was a trading error. Again coincidentally, there were barely two trading days before DRB-CE was suspended last Thursday (last trading on Wednesday, July 27).

After all, if DRB-Hicom shares closed at or below RM1.95 five days before expiry, the European-style call warrants would have been rendered worthless on expiry, and the issuer would not need to cough up any money for cash settlements.     

Fortunately, DRB-Hicom shares rebounded and recouped all their losses the next day. On the final trading day, DRB-CE closed at 12 sen and the underlying share finished at RM2.24.

But the episode was unusual enough to elicit a response from OSK Investment Bank.

It issued a press release in response to The Edge Financial Daily article on the “trading error”, saying that it had absolutely nothing to do with the price decline.

“We, the bank, would like to clarify that we were not involved nor did we have any prior knowledge as to the purported ‘trade error’ reported in the article.”

OSK, however, said there might be a direct implication on the determination of that day’s price movement on the settlement price of the call warrants.

Whether there were suspected trading irregularities, Bursa Malaysia said as a matter of policy, it does not comment on any of its investigative actions.

In an email reply to The Edge Financial Daily, it said: “Bursa Malaysia takes the obligation to maintain market integrity as a priority and views any attempts to manipulate share trading seriously. Where there are instances of suspected market offences, the exchange will investigate and take the necessary action.”

It is still unclear what happened in those final minutes of trading on July 25, but the episode does throw up a few lessons.

For one, it highlights the riskiness of call warrants, which many investment banks have been busy issuing and are often snapped up by retail rather than institutional investors.

The high gearing effect means investors can either gain a lot or lose it all.

Second, the ending value of a call warrant despite its multi-month tenure, ultimately depends on the closing price of just five trading days in the case of DRB-Hicom. If the underlying stock price had fallen below the call warrant’s strike price for that five days, it would have rendered the warrants worthless.  

Third, this may encourage future investors to just sell their call warrants on the open market if they make a profit, rather than wait for expiry and settlement.  

Fourth, it highlights the need for the authorities to exercise greater vigilance on unusual share price movements, especially when a call warrant is due to expire.

Finally, the issuer of call warrants also needs to take into account a stock’s longer-term prospects before issuing such instruments — or they risk being out of the pocket.

In DRB-Hicom’s case, few would have foreseen just a few months ago that the low-profile diversified conglomerate would have emerged on institutional investors’ buy lists. DRB-Hicom started garnering attention after analysts started appreciating its undervalued assets and it later acquired a 32% equity stake in Pos Malaysia Bhd.

Perhaps the most important lesson is that call warrants are a risky instrument for both the issuer and investors.

This article appeared in The Edge Financial Daily, August 1, 2011.