Convertible warrants of mortgage lender Housing Development Finance Corp. Ltd (HDFC), which were issued last August, are trading way below fair value.
The warrants were priced at Rs. 55 (adjusted for the stock split) at a time when the company’s shares traded at a discount of around 25% to the exercise price of the warrants.
The pricing of the warrant—which is essentially a call option —suggested an implied volatility of around 25%, using the then prevailing dividend payment of Rs. 6 a year. Incidentally, the volatility in HDFC shares has been 25% in the past one year.
HDFC shares have risen by around 63% since then and the warrants have almost turned in-the-money. This has resulted in a sharp rise in the price of the warrants to Rs. 159 each.
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