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Derivatives
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Stock Options
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Stock Warrants
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Interest Rate Swaps
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Interest Rate Caps, Floors
and Collars
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Swaptions
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Futures and Forward
Contracts
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Managed Futures
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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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