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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!

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"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).

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  • $\begingroup$ Hi Jan, thanks for your input; you are right about selling the more expensive item and hedge the position which is cheaper to make a profit. Regarding the warrants, I am not talking about company warrants but structured warrants, i.e. bank-issued warrants, e.g. on the DAX in Germany. As I am using them or their implied vola to price structured products on the DAX, I just wanted to ask if someone might know how big differences in volatilities between exchange-traded options and structured warrants are, in general, or averagely. $\endgroup$
    – John Denim
    Apr 27, 2021 at 13:32
  • $\begingroup$ @JohnDenim: I see, apologies I misunderstood the question. I am not that familiar with structured warrants (seems like they're just OTC Options, with custom terms, possibly cash-settled?). My thoughts are that Implied Vol is basically the price of an option, and price tends to be proportional to liquidity. So if the OTC Warrants are less liquid than exchange-traded options, I would assume that the buyer of such less liquid instrument would want to be compensated via a discount, relative to the exchange-traded options: therefore I'd assume the IV on the warrants is lower (not sure by how much). $\endgroup$
    – Jan Stuller
    Apr 29, 2021 at 11:25
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"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.

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