What Is a Warrant Premium?
A warrant premium is the difference between the current traded price of a warrant and its minimum value. A warrant's minimum value is the difference between its exercise price and the current traded price of its underlying stock.
Alternatively, a warrant premium is the percentage difference between the cost of purchasing shares by exercising a warrant and buying them in the open market at the current price.
- A warrant premium represents the additional value of a warrant above its stated minimum, which can be estimated as the difference between its strike price and the market price of the underlying.
- It can also refer to the premium given to exercising a warrant over buying shares in the open market.
- A warrant is a type of call option granted by companies that gives employees or managers the right to purchase company shares in the future at favorable terms.
Understanding a Warrant Premium
Warrants have both a price and a premium. Typically, the premium will decrease as the price of the warrant rises coupled with the decrease in the time to expiration. A warrant is in-the-money (ITM) when the exercise price is less than the current share price. The more in-the-money the warrant is, the lower the warrant premium. High volatility may also cause the warrant premium to be higher.
As with call options, the premium can increase or decrease depending on supply and demand factors.
Calculating the Warrant Premium
For the simple definition, the premium is the amount above the intrinsic, or minimum value.
- Premium = current price of the warrant - minimum value
- Minimum value = exercise price - current price of the underlying stock
Example of Warrant Premium
In this example, if the warrant price is $10, the exercise price is $25, and the current share price is $30, then the warrant premium would be $10-( $30-$25) = $5.
For the second calculation, the premium, expressed as a percentage, is the difference between buying warrant shares vs. buying shares through the open market.
- Premium = [(Warrant Price+Exercise Price-Current Share Price) / Current Share Price] * 100
For example, an investor holds a warrant with a price of $10 and an exercise price of $25. The current share price is $30. The warrant premium would be [( $10+$25-$30) / $30] * 100 = 16.7%.
Warrants tend to trade at premiums because traders believe that the underlying stock can increase in price. Therefore, the longer the time until expiration, the longer the stock has to rise. However, as with options, as expiration approaches, the premium shrinks.
Difference Between Options and Warrants
A warrant is similar to a call option. It gives the owner the right, but not the obligation, to buy an underlying security at a specific price, quantity, and at a future time. Warrants are unlike an option in that it is issued by a company, whereas an option is an instrument of the stock exchange. The security represented in a warrant, usually share equity, is delivered by the issuing company instead of by an investor holding the shares. Traders cannot write warrants.
Companies will often include warrants as part of a new-issue offering to entice investors into buying the new security.
While most listed options have a maximum expiration term of one to three years, warrants may have expiries of up to 15 years or more.
How Do Warrants Differ From Company Stock?
Warrants are sometimes given by companies to their employees as a form of equity compensation known as employee stock options (ESO). Because they are options contracts, they do not pay dividends nor have any voting rights. The warrants, however, may be exercised and converted into shares.
What Is a Warrant Sweetener?
Sometimes a company will attach warrants to other securities that it issues in order to raise capital, making the issue more attractive to investors. For example, a warrant may be attached ("wedded") to corporate bonds or preferred shares. This is known as a "sweetener."
How Can Warrants Dilute Earnings Per Share (EPS)?
Earnings per share (EPS) is a key metric followed by investors and analysts. It is computed as a company's net income for a certain period divided by the number of shares outstanding. Warrants, however, can have a dilutive effect in that these contracts represent potential new shares that are not yet available. Therefore, fully-diluted EPS is often preferred, which takes into account all potential new shares that could be brought about through warrants, other employee stock compensation, and convertible securities.
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