Investing In Warrants

By Sham Gad | October 15, 2010 AAA

Though it's an often cloudy area of investing, warrants can be worth digging into. Warrants, in a simplistic analogy, are a lot like long term call options but instead issued by the company for various reasons. Often a company will issue warrants as a part of a secondary equity offering as a way to entice existing and future shareholders to participate in the offering. In some cases the warrants remain embedded in the equity. In other cases, the warrants will trade in the public market.

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Strong Potential Upside
Like options, the appeal of warrants is the potential upside if the stock prices moves favorably. Another advantage is that many warrants are usually issued for several years versus two years for the longest dated options. The longer the time, the greater chance for the warrant appreciate in value.

For instance, insurance company Homeowner's Choice (Nasdaq:HCII) has HCII Warrants (Nasdaq:HCIIW) that expire on July 30, 2013. Two warrants allow you to buy a share of HCII for $9.10. The warrants last traded for 68 cents and shares of HCII currently trade for under $7. In other words, investors are paying $1.36 - the price of two warrants - for the right to buy one share of HCII for $9.10.

If by expiration shares in HCII aren't trading above $9.10, the warrants are worthless. If you buy them at the current price and the shares in the company don't trade above $10.46 ($9.10 + $1.36) on expiration, you will lose money. So the work is in analyzing Homeowner's Choice and determining if shares are likely to appreciate over time.

Remember that the warrant price will fluctuate between now and expiration. So if HCII shares are trading at $9 next year, the warrants will likely be trading higher. It's also important to consider whether investing in stock or warrant is the better bet. If shares in HCII are trading at $11.00 at expiration, each warrant should be worth approximately 95 cents, or a 50% upside from today. However, shares in HCII also trade for $7 today; at $11 the gain is over 50%, so in this scenario the stock is better bet.

Consider Your Options
USA Technologies (Nasdaq:USAT), a provider of cashless devices to vending machines, kiosks, and various other assets, has USAT Warrants (Nasdaq:USATZ) that expire on December 31, 2013. The warrants entitle the holder to purchase one share of common stock at the exercise price of $2.20 per share of common stock. Today, the warrants trade for 50 cents and shares of USAT trade for $1.29. In this case one warrant conveys the right to buy one share.

Wells Fargo (NYSE:WFC) recently issued warrants that expire in October 2018. Each warrant represents the right to purchase one share of common stock at an exercise price of $34.01. Today, Wells Fargo trades for $24.75 and you have eight years worth of time value on the warrants. If shares in Wells Fargo double to $52 in the next eight years, the warrants will be worth $18. However, with eight years of time any surge in WFC shares would cause the warrants to increase significantly.

No Guarantees
Warrants are another type of option like security on a stock. Yet because many warrants have a long time prior to expiration, they can potentially offer an interesting way to bet on the underlying stock. (To learn more, check out Warrants: A High Return Investment Tool.)

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