Effective Gearing

What is effective gearing?

Effective gearing is the most widely used measure of a structured warrant's true leverage — it answers the practical question: if the underlying moves 1%, by approximately what percentage does the warrant price move? It is calculated by multiplying simple gearing by delta. A warrant with 10× simple gearing and a delta of 0.30 has an effective gearing of about 3×, meaning a 1% rise in the underlying should produce roughly a 3% rise in the warrant.

This makes effective gearing a more honest leverage metric than simple gearing, because it factors in the warrant's actual sensitivity to the underlying at this moment, rather than assuming the warrant tracks dollar-for-dollar.

Worked example: comparing two warrants by effective gearing

Warrant A: underlying at RM5.00, warrant price RM0.10, conversion ratio 5, delta 0.25. Simple gearing = 5.00 / (0.10 × 5) = 10×. Effective gearing = 10 × 0.25 = 2.5×.

Warrant B: underlying at RM5.00, warrant price RM0.30, conversion ratio 5, delta 0.60. Simple gearing = 5.00 / (0.30 × 5) = 3.3×. Effective gearing = 3.3 × 0.60 = 2.0×.

Despite Warrant A having triple the simple gearing, its effective gearing is only slightly higher than Warrant B's — and Warrant B, being deeper in-the-money (higher delta), carries less risk of expiring worthless. Effective gearing surfaces this trade-off; simple gearing alone would have been misleading.

When to use effective gearing

Use effective gearing when sizing a warrant position or comparing two warrants on the same underlying. It tells you the approximate percentage impact on the warrant's price per 1% underlying move. But remember: effective gearing is a point-in-time estimate — it changes as the underlying, delta, and time to expiry shift. For this reason, traders recheck effective gearing before and after significant underlying moves, not just at entry.

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