Skip to content
All library documents

Warrant Implied Volatility, Issuance Limits, and Arbitrage

Article Quant Q&A · Author: John Denim
Read the original

Summary

The discussion asks whether warrants carry higher implied volatility than comparable exchange-traded options, whether the difference can be exploited, and whether warrant volatility can help analyze structured products. The answers explain that an apparent volatility premium would generally suggest selling the expensive warrant and hedging with cheaper options. But warrants are issued by the linked company, which limits who can create and sell them short; holders may also face thin secondary-market liquidity, making an apparent arbitrage hard to realize.

The replies note that warrant arbitrage based on volatility differences has a long history, dating to early applications of Black–Scholes theory. They offer no current measurements of typical volatility gaps and caution that apparent discrepancies may reflect illiquidity rather than available profits. The discussion does not resolve whether warrant implied volatilities are suitable for duplication analysis of certificates, so that application needs further evidence and instrument-specific checks.

Key ideas

  • A higher warrant implied volatility relative to comparable options could indicate relative expensiveness.
  • A theoretical hedge would sell the expensive warrant and buy cheaper options.
  • Only the linked company can issue its warrants, limiting other traders’ ability to establish short positions.
  • Warrants may be illiquid, so observed volatility differences may not translate into executable arbitrage.
  • The discussion provides no empirical estimate of typical warrant-option volatility differences.

Tags

OptionsVolatilityArbitrageDerivatives pricing
Full text
# Differences in implied volatilities of warrants and options


# Differences in implied volatilities of warrants and options












I have another question regarding the implied volatilities of warrants: When it's said they are overpriced compared to classical options, that means their implied volatility is higher than for similar options with same strike and maturity, right? Does anyone have an idea or source of how big the difference in volatilities is? And why don't other banks exploit too expensive warrants by buying them from their peers and hedge the position at the EUREX?

Can warrant IVs still be used for the duplication method of analyzing price differences of structured products (certificates)?

Thanks, I really appreciate any answers!

## Answer by Jan Stuller (score 3)

https://quant.stackexchange.com/a/63545

"And why don't other banks exploit too expensive warrants by buying them from their peers and hedge the position at the EUREX?"

If the warrants are expensive relative to options, the way to exploit them is to sell them and buy the cheaper options as a hedge, not to buy the warrants. And that is the reason why they cannot be exploited in the way you suggest: warrants (by definition) are issued by the company to which the warrant is linked, i.e. only a treasury of a specific company can issue (sell) warrants.

Then, if the counterparty chooses to exercise the warrant, the treasury of the company that issued the warrant will typically issue new shares to settle the warrant, rather than purchase shares in the market and deliver these.

Any other entity, except for the company that issues the warrant, cannot "short" the warrant: you can only buy the warrant from the issuer and then sell it later if you choose to (and if there is a party willing to buy it: I doubt warrants would be very liquid in the secondary market).

## Answer by nbbo2 (score 3)

https://quant.stackexchange.com/a/63548

"Warrant Arbitrage", the attempt to take advantage of warrants mispricing in volatility terms was one of the first applications of the Black Scholes theory decades ago. I don't know where things stand today, but I doubt that there are large volatility discrepancies today (although as pointed out in other answer warrants are not very liquid so it may be difficult to cash in on apparent arbitrage profits, they may be more apparent than real). But the strategy is well known.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.