Thought I would post this article on warrants, given that SFTBF does have them. I needed to brush up on the difference between options and warrants in terms of risk reduction and leverage--this article provides a good overview:
Warrants: Birthday Presents from IPOs
By Julia Hong Sabella, 4/10/00
The life cycle of a company is similar to that of an individual. The Initial Public Offering (IPO) date-the day a stock commences trading on an exchange-can be thought of as the stock's first birthday. Just as there is some gestation period in procreation, however, most companies are held privately in some form prior to the birth of their IPO. Warrants are typically part of initial public offering scenarios and offer traders a unique investment alternative.
Warrants are issued in small quantities and considered to be hybrid securities. Since IPOs involve several securities firms and the raising of capital, warrants are given to the firms as well as the executives and management of the newly traded company as incentives, like bonuses for the future. Quite often, there is more than one class of warrants, usually denoted by Warrants A, Warrants B etc. The symbol and warrant classes of common stock shares usually have a suffix of "w," "z" or "ws" appended to the stock symbol. In addition, "wt" is usually appended to the company name to denote its warrant status. Warrants do not necessarily trade on the same exchange as common stock since they are less liquid.
Are warrants like options? As mentioned before, warrants are hybrid securities, i.e. they have qualities, advantages and disadvantages similar to other securities. On the plus side, they have longevity, similar to leap options. The expiration dates are usually at least a year or more in duration. However, it is a very specific expiration date unlike the call and put options of stocks. In many ways warrants act like options in that they share the following attributes:
A strike price, known as the conversion price (such that when the common stock share price is trading above the conversion price, the warrant behaves like an in-the-money call option)
A premium that fluctuates
Limited investment cost plus leverage characteristic of a leap option.
A bid and ask spread on pricing (the spread can be significant).
Expire worthless on their expiration date unless converted into the common stock shares prior to expiration
Exercising options results in acquiring round lot shares. Warrants when exercised have a specific formula for shares, typically, one warrant for one share or two warrants for one share. The information is available from the company's investment department or prospectuses. Unlike options that have a set schedule for creation and expiration, warrants are issued only once
What are some of the disadvantages? Since most IPOs are small or micro cap companies still in the development stage, a significant number of warrants are held by inside management as an incentive for developing products and stimulating sales. However, some warrants are callable. Warrant holders must watch for company news more often since mergers and buyouts do happen and the warrants are called. In addition, unlike common stock, there are no voting rights or warrant shareholder meetings. As mentioned previously, the pricing for a warrant may indicate a large bid-ask spread. Some brokers do not like to trade warrants because of the cheap price, similar to a penny stock-typically $5.00 or less per warrant. However, a few years ago, the Intel (INTC) warrants traded over $65.00 per warrant.
Most investors are not familiar with warrants unless they read the Nasdaq Small Cap Market listings. Whereas the common stock shares are traded on the larger exchanges or markets, the warrants are traded on the Small Cap Market. This investment like other securities may later list on a different exchange or market. Although warrants are a highly leveraging, fixed cost investment, they cannot be combined to create credit or debit spreads or other option strategies. Their closest relative is the call option, not the put option. When warrants are part of the IPO package, no options will exist on the common stock shares because the trading patterns, pricing, and liquidity of the common stock shares must meet specific criteria of the options exchanges before the options can be listed.
Does a warrant investment deserve a place in an investor's portfolio? Option investors might appreciate the flexibility of a warrant investment after reading the appropriate investment materials concerning the fundamental business of the company and the specifics on conversion. For many investors who are unable to receive shares at the time of the initial public offering, warrants are a security that allows them to participate in the markets. Since warrants are similar to leap options, the investor can wait a period of time for the warrant price to stabilize and watch the earnings of the company to indicate the appropriateness of the warrant or stock share purchase. Since the warrant price is typically a third of the common stock share price or less, the outlay of dollars for this investment is less than for an equivalent stock share purchase. As in purchasing options, there may be some buying restrictions on trades because of liquidity. Please consult your advisor on the exact specifics and merits of the company prior to any purchase. Concerning capital gains and holding periods, check with your tax advisor concerning the tax rates. A wonderful reference guide is Tax Facts 2, a yearly publication from National Underwriter, a firm located in Cincinnati, Ohio (phone-800-543-0874, fax-800-874-1916).
Sometimes, the investor receives the warrants as taxable and nontaxable dividends, a gift from management to shareholders. The warrant's tax basis is usually the warrant's price on the date of the dividend distribution, not the declaration date. When should an investor sell this investment? As with options, the investor can exercise the warrant to convert it into common shares, allow it to expire worthless at expiration date, or exit the position by selling and receiving cash. Money management strategies can be used when holding a position, such as selling half the position when the warrant price has doubled to recoup the initial investment money and then selling the rest at a future date.
One of the best sources for warrant information is The Bowser Warrant Register, a monthly newsletter from Newport News, Va. (phone-757-877-5979, fax 757-595-0622). This report restricts its reporting to low price warrants, rates the warrants and comments on the companies. Barron's lists the warrants after their common stock with other information. The national investment newspapers, Investor's Business Daily and the Wall Street Journal have daily prices.
Caveat Emptor: Prior to purchase, be fully informed as to the merits of the company, its products, the long-range company plans, and the appropriateness of the investment. Quite often, the venture investor will purchase the warrants and exercise them into stock shares later. The option investor will hold the warrants for their leverage effect, sometimes in conjunction with the common stock shares.
Thus, when you see an IPO of a company that is a desirable investment, you may want to consider warrants as an alternative to buying shares or options. The IPO date is the first birthday of the company's shares trading at an exchange-a significant date in the life cycle of a company, and an indicator of growth and development.
Good luck in your investing endeavors.
Julia Hong Sabella
Options Strategist
Optionetics.com
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