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Equities fell back last week, and appear to be in a phase of consolidation now. The FTSE 100 Index, which hit 4500 at the very start of June, returned below 4250 last week as investors took some profits from the spring bull run. Put warrants on the index made some gains, with the short-dated FTSE 100_4600_Put_17-Jul-09 (SM09) series for example rising by 31% over the week.

Certain equities took a much harder hit. The oil sector continued its recent downward trend, with BP failing to impress the market with its new chairman and Royal Dutch Shell also being damaged by news of a militant attack on its operating facilities in Nigeria. Royal Dutch ‘B’ shares fell over the week from 1608p to 1510p, pushing up the value of the RDSB_1500_Put_18-Sep-09 (SB58) covered warrants by 45%.

Also on the way down was Legal & General in spite of an upgrade from Bank of America Merrill Lynch, who moved their rating from ‘underperform’ to ‘neutral.’ This was overshadowed by news of 200 job cuts in Cardiff, Hove and Kingswood in the company’s life products and annuities divisions. L&G shares slipped from 61.5p to 55.5p, which meant that the LGEN_60_Put_18-Sep-09 (SF67) covered warrants moved into-the-money and up by 26% on the week.

Suffering as well was GlaxoSmithKline, which gave back half of its recent gain, falling over the week from £11.15 to £10.75. On Friday the company lost a court case over the Irish patent rights to its Seretide asthma drug, and it seems as if the tide of sentiment has turned against the company for the moment. We have seen a couple of press articles about the pressures on large pharmaceutical companies faced with inroads from cheaper generic medicines and the possibility of US healthcare reform. The out-of-the-money GSK_900_Put_18-Dec-09 (SI80) covered warrants rose by 31% over the week.

We’ll end with a brighter spot. Shares in the miner Anglo American bounded ahead from £16.23 to £18.00 after a bid approach from Xstrata, which was rebuffed by Anglo’s management. A lengthy battle could ensue, although there is no certainty that Anglo will succumb. The investment bank Barclays Capital has just upgraded Anglo American shares from ‘equal weight’ to ‘overweight’. They said Anglo will likely defend itself a merger with Xstrata, which could produce a higher bid or a white knight willing to pay a premium for the group. Barclays Capital said it also believes Anglo's focus on improving operating performance "will eventually result in better earnings, translating into a higher equity valuation and share price." The AAL_1800_Call_18-Jun-10 (SL59) covered warrants rose by 30% over the week. We would suggest that investors buying calls on the stock because they expect a positive outcome to the takeover manoeuvres should be wary of covered warrants which are well out-of-the-money. There is a risk that out-of-the-money call covered warrants could expire worthless if a deal (other than an all-share deal) is concluded at a value less than the strike price. In this case we think any workable deal is likely to involve a share swap, in which case the terms of the covered warrants can be changed to reflect the terms of the deal, but nevertheless it is sensible to be aware of this extra potential risk.

Andrew McHattie