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Stock Warrants

Stock Warrants are rights to buy stocks at a certain price until a certain date. They are similar to call options (covered in the next chapter), in that they can be exercised to obtain common shares at a fixed price. The difference is that warrants normally carry a long term limit before they expire (such as five or more years) and when exercised, new common shares are issued by the company to cover the transaction, unlike call options, where the options are based on the already outstanding shares and are created and sold by the shareholders.Warrants are sometimes issued to the previous common shareholders of a company that is just emerging from bankruptcy (at least this is better than nothing). Since normally the exercise price of the warrants is higher than the current stock price, holders must wait until the stock price surpasses the exercise price before they exercise their warrants.

For example, a company emerging from bankruptcy with its new stock value at $10 per share may issue five-year warrants with an exercise price of $30 per share. There is nothing to be gained by the holders exercising these warrants and buying the stock for $30 per share when they can buy it on the market for $10. But if the stock price happens to reach $40 per share before the five years is out, it would make sense to exercise the warrants at $30 per share and then sell the stocks on the market for $40, if desired. If the stock doesn’t make it past $30 a share in five years, the warrants expire worthless. Can one sell the warrants rather than exercise them? Yes. The higher the stock and the further away the expiration date, the higher the warrant price. In our example of five-year warrants with the $30 exercise price, the warrants may be worth $10 a piece. As the expiration time draws near, the value of the warrants dwindles if the stock price stagnates. But if the stock price increases, the warrants would also get a boost depending on the …