Introduction

Investors are missing out on an excellent way to leverage the return of investments in stocks that provide stock warrants, so it is unfortunate that almost all Americans and most Canadians (investors, brokers, financial advisors/planners and financial writers alike) are either unaware of, or not very familiar with, warrants. This article is my attempt to change that.

What Is A Stock Warrant?

A warrant is a security giving the holder the right, but not the obligation, to acquire the underlying security at a predetermined (i.e. exercise) price and for a specified period of time (i.e. expiration).

What Is a Warrant Strike Price?

The “strike price” is the price at which you can buy the stock of the associated company at some point in the future. If a warrant has a strike price of $2, for example, you will be able to buy company stock at $2 at some point in the future but until it reaches that price the warrant has no intrinsic value. If the company were to achieve major success and see its stock price soar to $6, the warrant would have an intrinsic value of $4, since it allows you to buy stock for $2 per share, which you could then sell for $6 per share.

When the share price of a stock is trading above the warrant’s strike price, we say the warrant is “in the money” and  “out of the money” when the stock price is trading below the warrant’s strike price. The closer the strike price is to the current stock price, the more likely the warrant is to go in the money or to expire in the money, and the more it will be worth.

What Is A Warrant Expiration Date?

The second aspect of a warrant you need to know about is the “expiration date.” This is the date at which the contract expires. After the contract expires, neither the company nor the holder have any rights or obligations associated with the warrants. If a warrant expires “out of the money,” it is worthless.

The further in the future the expiration date is, the more time a company has to achieve success: and the higher the share price, the more the warrant will be worth. In other words, all things being equal, a “3-year” warrant is worth more than a “1-year” warrant and a “5-year” warrant is worth more than a “3-year warrant. It’s rare that valuable “5-year” warrants are issued by companies.

What is A Warrant Conversion Ratio?

The conversion ratio of a warrant is the number of shares applicable to the warrant. Some warrants are good for one-quarter of a share, which is known as a quarter warrant. This means you need four warrants to buy one share; some are good for one-half of a share (you need two warrants for one share). These are called “half warrants” and some warrants are good for a full share (you need one warrant for one share). These are called “full warrants.” Obviously, a full warrant is better than half a warrant so you want warrants that can convert into as many shares as possible.

Steps for Successful Warrant Investing

1. Determine which companies offer long-term warrants.
2. Choose a company that offers a long-term warrant of at least a 36 months expiration date (a 48 or 60 month expiration is preferred) because the longer the remaining life of a warrant the more time there is for the company to execute on their business plan and more time in the event of a market downturn for a favorable turnaround.
3. Select a company that you think has great potential because if the company does not perform and execute on its business plan the common shares will not rise and, therefore, their associated warrants will nor rise either and, if the common shares decline, their associated warrants will decline by an even greater percentage. Visit the company's web site for their latest activity and results and review the company's latest quarterly financial results to determine their financial health.
4. Identify a warrant currently priced to deliver an enhanced return of at least 1.5-to-1 (i.e. a 50% greater return than the associated stock) based on your due diligence (go here for an example of how to calculate the Return on Investment (ROI) of a warrant as compared to the associated stock).
5. Look for a warrant that has a high strike price as this makes the warrant more likely to go expire “in the money” and have intrinsic value.
6. Choose a warrant with a high conversion ratios because you want the warrant to convert into as much stock as possible. 
7. Buy your chosen warrant when you think the market is favorable because, while warrants out-perform their associated stock in an up market, they under-perform much more so than their associated stock in a down market.
8. Don't forget to sell the warrant before it expires (applicable to both American and Canadian investors) or, for Canadian investors only, to convert the warrant into the associated stock if the exercise price has been reached prior to the expiration of the warrant.

How Do You Buy Warrants?

Warrants trade exactly like the underlying common stock and, as such, they are assigned a symbol. That being said, however,  most online brokers are not set up with symbols for the warrants you might wish to buy so it will be necessary to deal with a broker directly and have him/her enter the order for you.

When American investors go online and see that a warrant of interest is trading with a U.S. symbol placing an order should be problem free. However, if it has a Pink Sheet symbol the price for the most recent bid or ask price should not be used as a basis for establishing a new bid or ask price because that price will just be the last trade in the U.S. and therefore may be days, weeks or even months old compared to the bid and ask prices on the more active Canadian exchanges. In such situations you should visit here for the up-to-the-minute bid and ask prices, as quoted in Canadian dollars. You will also need to go to a currency conversion site to get the current U.S. dollar to Canadian dollar exchange rate because you will be buying the warrants priced in Canadian dollars.

Keep in minds that warrants usually have very thin markets (i.e. demand) and, as such, usually have a big spread between the bid (the price at which you are willing to make a purchase) and ask (the price at which you are willing to sell) price. As such, it is imperative that you place only “limit orders” when buying or selling warrants associated with Canadian commodity-related stocks. The same advice applies to Canadian purchase and sale of warrants.

How Do You Sell Warrants?

Some investors erroneously believe that you have to hold warrants until the expiration date but that is the worst thing you can do because when warrants expire they will do so without any monetary value i.e. they are worthless. Instead, investors must sell then when the warrants have met their price objective or well before they expire.

There are two kinds of orders that can be placed when attempting to buy or sell a security:

1. Market Orders: A market order does not have a set price and is therefore executed immediately at the current ‘market’ price. Markets, especially OTC markets, can be highly volatile, and the price of execution may differ dramatically from the price at time of order entry. Those who use market orders are more concerned about the speed of the execution as opposed to the price.
2. Limit Orders: A limit order has a set price and may only be executed at the set price; however, a limit order may never get executed because the market may move away from the set price. Those who use limit orders risk not having an order executed.

How Do You Exercise Warrants?

It is important to note that if your warrant is “in the money”, i.e. the common stock is trading above the exercise price of the warrant, and the warrants are approaching the expiration date, you must take action because when warrants expire they expire worth absolutely nothing!

• From an American perspective: 
  • You have only one viable option and that is to sell your position before the expiration date (and doing so 6 to 12 months before the expiry date is highly recommended because the value of a warrant often drops drastically during its final months of life) because, according to U.S. law, Americans cannot exercise a Canadian warrant unless its associated shares have been registered with the SEC because, should they exercise a warrant, they would be receiving a newly issued share which would be illegal.
  • Keep in mind that your broker may need to be educated on how to exercise an order. As such, never ‘ask’ your broker if they will execute your order for warrants but, instead, ‘tell’ them exactly what you want them to do. If you just ‘ask’ many brokers will say they don’t trade in Canadian warrants so they can’t execute your order. However, if you ‘tell’ them exactly what you want them to do on your behalf most will be more than happy to comply.
• From a Canadian perspective:
  •  You have the option of either exercising a warrant (i.e. converting it into the stock of the associated company according to the terms of the warrant) once it is “in the money” or selling it outright at any time before it expires.

Why Should You Consider Investing in Warrants?

On average, warrants are usually priced about 60% less on average than their associated stocks and, therefore, you are in an ideal position to leverage your dollars very effectively. Investing in warrants gives you the opportunity to earn more dollars (in percentage terms) with considerably fewer dollars at risk.

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