What they are, how to trade them, why trade them
Each month, we dedicate the front page of the yellow supplement to warrants. Highlighting warrants is something Mr. Bowser started over twenty years ago. Still, many subscribers wonder what they are, how to trade them, and why trade them.
Warrants are risky. Warrants are volatile. However, for those who can stomach the ups and downs, along with the increased possibility of losing money, warrants can provide tremendous rewards.
WHAT ARE WARRANTS?
The basic definition of warrants: they are options a corporation issues to buy a number of shares (usually one) of its common stock at a given price for a specified period of time. A company can also issue warrants for stock it owns in another company, for fractions of a share of common stock, for multiple shares of common stock, or for bonds or preferred shares.
Companies issues warrants most of the time as incentives, as Mr. Bowser would say, “to sweeten the pot.” When a company issues its Initial Public Offering (IPO), or another offering, it may throw in a warrant with each share of common to boost the offering’s attractiveness.
Warrants also raise capital for companies. Each time an investor exercises a warrant, the company receives funds. And, the company doesn’t have to pay back the funds, nor do they have to pay interest like they would for a bank loan.
The first warrants ever listed on a major exchange were AT&T warrants. Now, each of the warrants we feature trades on a public market. Warrants’ trading symbols are usually the same as that of the common, except that a “W” appears at the end of a NASDAQ symbol. NYSE, AMEX and the OTC Markets Group have their own warrant symbols.
Most investors new to warrants think that they have to exercise them, holding the warrants until the exercise price is reached and converting them into common stock. However, that is not the case (as only about 20% of warrants issued are converted), nor is that our approach to warrants.
We simply recommend buying and selling warrants based on the Game Plan, with a few added guidelines. First, when buying a warrant, we prefer it to be less than $1. We also like there to be two years or more before it expires. Other than that, we follow the Game Plan: sell half at the double, sell the remainder when the warrant pulls back 25% from its most recent high.
TRADING TERM: Intrinsic value speaks to how valuable the warrant is. If the common stock is trading above the strike (exercise) price, the warrants have intrinsic value, or they are “in the money.” If the stock is below the strike price, the warrants have only time value, or are “out of the money.”
WHY TRADE WARRANTS?
Like trading minipriced stocks, the number one reason to trade warrants is leverage, except that with warrants the leverage increases! Mr. Bowser said it best: “Once a stock begins moving up, one dollar invested in the company’s warrants can do the work of several dollars invested in the common.”
As a stock approaches the strike price, the warrants, which trade for less, appreciate more. As an example, Homeowner’s Choice (HCI) common stock rose from $10.90 to $14.76 from March 1, 2012 to May 2, 2012–a 35% gain. Over the same period, the warrants rose from $0.90 to $2.99–a 232% gain. 1,000 shares in the common would have yielded around a $354 profit, but 1,000 warrants, a $2,322 profit.
As we often note, leverage goes both ways. From March 1, 2012 to May 2, 2012, Ford Motor Company’s common stock slipped from $12.66 to $11.10–a 12% loss. Over the same period, the warrants slid from $3.72 to $2.31–a 38% loss.
As time goes on, warrants are increasingly harder to come by, a problem Mr. Bowser alluded to often. There have simply been fewer offerings recently, as the IPO market has gone relatively quiet. Still, we try to provide a number of warrants each month, adding two new ones this month.
Warrants are not for everyone. Those without tough stomachs and level heads should stick to common stock. But, for those who can handle it, and enjoy the ride, warrants might just be your thing.