Well not quite...
Most of your post is well informed, but you are misinformed on a few (some rather key) issues. In particular,
>Using the current conversion price of $40.25, the warrants should never sell for more than 40.25 less than the Intel share price.
This is not correct as one can tell by looking at the current INTC/INTCW price relationship. INTCW is basically a leveraged position in INTC. In other words buying INTCW is equivalent to buying INTC and then borrowing $40.25 (really $41.75) to help finance the purchase. Because INTCW's price embedds the borrowing costs into the upfront cost, it's price WILL typically be in excess of INTC - 41.75. As the time to expiry falls, the value of the borrowing decreases and INTCW will converge to INTC - 41.75 (absent a crash in the price of INTC to below 41.75 of course).
>Actually, since the premium has only been about $1.00 lately, the implicit borrowing cost of $40 plus the increase to $41.75 is only about 4% per year!
You are getting confused here. The "premium" as you define it is actually more like $2.5 - $3. At any rate you are treading on dangerous territory trying to generate an effective borrowing cost by simply using the strike price (as the borrowed amount) and premium (as the interest amount). To accurately determine the true embedded borrowing cost for a warrant or option requires the use of mathematical models (can you say Binomial Option Model?) and the determination of what is called "implied volatility". In short using implied vols from the OTC Jan 98 call market (about 31%), INTCW has been trading at an implied financing rate of 5.7-6.1%. Not surprisingly this is almost on top of where large institutional borrowers can obtain 15mo zero coupon term financing. (Oh, an efficient market!).
>Clearly for most small investors, you should buy the warrants instead of the shares.
I have to disagree. We have already determined that the financing cost for INTCW is around 6%. It is true that this is substantially below where most retail investors can get margin funds. However what most retail investors do not think about is the internal logic behind buying INTCW ie. leveraging to buy INTC. To wit, why are you (the retail investor) borrowing at 6% when you are also probably lending to a bank (via a CD or savings account) at 3-5%? It would make more sense to simply utilize your cash reserves to buy more INTC. This is the internal inconsistency behind most retail purchases of INTCW. Unless you are already fully invested, it is more logical to liquidate your cash reserves (including bond and money market mutual funds) and buy more INTC than it is to buy INTCW. This talk about buying INTCW is simply bizarre. It is totally illogical unless you already have everything and I mean EVERYTHING ploughed into INTC. The killer to top of all of these issues is that "borrowing" via INTCW is tax inefficient. It converts a current tax expense (up to 40% tax benefit) into a future capital tax loss (28% benefit). All in all NOT a good idea for most retail investors.
Playing the short squeeze - the only time this would be likely to occur would be near expiration (in '98). In order to take advantage of an overly high price of INTCW relative to INTC, one would have to sell their position in INTCW and buy INTC. Unfortunately this WILL result in a capital event for tax purposes. And there's the rub. If one were to buy INTCW today at say, 100, and it was sold for $150 vs. an intrinsic value (INTC minus strike price) of $148, the $2 mispricing would be a gain to a INTCW holder, but is would be totally swamped by the capital gain taxes of $14 ($50 * .28). Sure you won't have this problem if INTC (and INTCW) don't go up, but then why'd you enter into a leveraged position on INTCW anyway? |
