What Are Warrants and ELWs — Highly Leveraged Derivative Securities

A warrant is a security that carries the right to buy or sell an underlying asset at a set price (the strike). The form listed on the exchange in Korea and traded by individuals too is the ELW (equity-linked warrant).

The structure is very similar to options. A call-type ELW profits when the underlying rises, and a put-type ELW when it falls. Unlike options, however, it is productized so it can be easily traded on the exchange like a stock.

Being able to bet on a large move in the underlying with a small amount is promoted as its appeal, but there is a large risk on the flip side.

The two core features of an ELW are 'high leverage' and 'time-value decay.'

Leverage: because you bet on the underlying's move with only a fraction of its price, even a small move in the underlying swings the ELW price several fold. If the direction is right, you gain big, but if it's wrong, it melts in an instant.

Time-value decay: an ELW has an expiration and, like an option, its value (time value) shrinks as time passes. If the underlying doesn't move as much as expected by expiration, the ELW loses value and can become worthless at expiration.

In other words, you must guess not just direction but also the timing of 'by when,' and if you miss, you can lose your entire investment.

ELWs are promoted with phrases like 'big returns with small money,' but flipped over, it means 'even small money is easy to lose entirely.'

If the underlying moves opposite to expectations, or even moves as expected but not quickly or largely enough, the time value disappears and a loss occurs. If there is no exercise value at expiration, the investment becomes 0.

Also, an ELW with low liquidity is hard to sell at a fair price when you want to, and with a wide bid-ask spread, trading costs are also large.

You must clearly understand that it is a short, dangerous tool, opposite in character to long-term, diversified investing.