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Derivatives

 - Stock Options

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Stock Warrants

A warrant is a long-term (3 to 10 years) stock option. It allows the warrant holder the right to purchase the common stock of a company at a set price (exercise/strike price) within a specific period of time. Warrant holders do not vote, they do not receive dividends and once the expiration date of the warrants is passed, they become worthless. It’s just a right to purchase a stock at a predetermined price, lasting for a specified period of time. The exercise period of warrants is long-term; options are more short-term.  The longer the duration the more valuable the warrants are. If the stock value increases above the warrant’s strike price it’s considered to be “in the money.”  Warrants are normally sold alongside debt offerings, to act as a yield enhancement. They are usually detachable and sold separately on the exchanges.

Warrants are typically used when issuing subordinated debt. If the sub debt lender is looking for a mid 20% return, 12% may be in interest (cash), with the rest in warrants. Some warrants are negotiated with a predetermined put price or valuation method, where the issuing company will repurchase the warrants at a set time and price. One of the most successful uses of options was back in the early 1980’s, when the federal government bailed out Chrysler. The government made a huge profit (after the government guarantee loans were paid back) by exercising its warrants years later.

Cashless Warrants

The “cashless exercise clause” is an important feature to know about if you are given warrants. It permits the warrant holder to pay for shares purchased by surrendering the right to purchase other shares under the warrant. This allows you to realize the value of the warrants without putting up cash. If you are in a position of receiving warrants, always ask to have this clause added to the contract.

If warrants are not registered with the SEC, they normally are not transferable.

Warrants are classified as a derivative product because, technically, they derive their value from the common stock of the company, which is a completely different instrument.

I have found that it takes approximately five years to substantially move a company’s financials upward. Warrants, therefore, are a valuable investment tool.

 

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