Warrants

When investing in the stock market, all options need to be considered. One long-term alternative comes in the form of warrants. Warrants—which are often presented as incentive to entice investors to purchase newly-issued common stock or bonds—are derivative securities that offer the right to purchase securities at a specific price within a certain time frame. The securities to be purchased typically come in the form of equity; and warrant issues offer the right, until a pre-established date, to convert those warrants into a set number of pre-priced shares of the associated stock.

The primary distinction between warrants and call options is that warrants are issued and guaranteed by the issuing company. Options, as exchange instruments, are not issued by the company. Also, the lifetime of a warrant is often measured in years, while a typical option is assessed in months.

Because a warrant purchaser does not buy the equity itself—but instead, the right to buy or sell such equity—a warrant lacks certain rights. Unlike equity security holders, holders of warrants are not entitled to dividend rights, pre-emptive rights, share in liquidation, management influence or voting/right to information.

As with any investment, there are risks inherent with this approach:

(1) Warrants expire.

(2) If the stock is below the exercise (or “strike”) price at the time of its expiration, the warrants will be worthless.

Warrants can be quite volatile, but their combination of price leverage and relatively long life makes them attractive for those investors who are willing to take on more risk to obtain potentially higher returns. The Turnaround Letter feels that warrants can be a good vehicle for aggressive investors because they magnify the price movement of the underlying stock.

In its September 2010 issue, The Turnaround Letter highlighted a number of bank warrants that the federal government received as part of the Troubled Asset Relief Program (known as “TARP”) during the 2008 financial crisis and later re-issued to the public. The Turnaround Letter re-examines this investment vehicle in February 2012’s “Revisiting TARP Bank Warrants.”

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