Conservative Speculation
Perhaps this sounds like an oxymoron but conservative speculation IS possible, and it's done through warrants.
Simply put, a stock warrant allows you to buy a given stock for a set price at any time during the life of the warrant. When new, warrants usually run three, four, five and sometimes even ten or more years in length. Additionally, unlike with their common stock cousins, the owner has no voting rights, no say in the corporation and receives no dividends. Just the right to buy the stock at a set price during a set time period.
An example might help to explain the value of this. Let's suppose you like XYZ, Inc. Its stock is currently selling for ten dollars per share and you think it's good for twenty dollars per share in the next few years. You could simply buy a hundred shares for one thousand dollars and be done with it. If the stock goes to $20 and you sell, you've made 100%.
On the other hand, you also notice that XYZ, Inc. has warrants selling for one dollar apiece that allow you to buy shares of the company for $15 (but remember it's currently selling for $10, so the warrants are "out of the money"). But let's assume you buy the warrants anyway and the stock rises to $20 (as you thought it would) within the life of those warrants.
Your return when you sell the warrant will be four times as great. You've made 400% on the $4 rise in the value of the warrant. The mathematical bases for this - an investment concept called "parity" - comes in here. Simply put, the maximum any new buyer would ever pay for a $20 stock is obviously $20. The minimum amount any seller of a $20 stock will sell for is $20 also. Consequently, if your warrant gives you the right to buy a $20 stock for $15, the $5 difference has to show up in the value of the warrant. The warrant you bought for $1 you could now sell for $5. But nevertheless, in effect the new buyer will always pay $20 for the stock - either $20 directly in the marketplace, or $5 for the warrant and an additional $15 when exercising the warrant. The money to be made is either in buying the stock for the price ($15) the warrant allows and then selling that stock for its market value ($20), or selling the warrant for a price ($5) reflecting its increase ($4) in value. So all things being equal, parity is the invisible referee of the market place.
The biggest benefit in using warrants is - if you are correct about both the growth and the timing of the growth - you can substantially leverage your returns. (You only had to put out $1 to buy the warrant as opposed to $10 for the stock.) But the key here is the timing. If you're wrong, and the stock doesn't go higher than the exercise price before the expiration date of the warrants, then you are out of luck. The warrants expire worthless and you lose.
With the stocks themselves, a month or year may not make a difference. With warrants, this time factor is crucial. And it is the key reason to buy warrants in the first place.
So here's how to go about picking and using warrants. First and foremost, make sure you like the company you are investing in, and that careful research has convinced you it will grow.
Next, check to see if the company has warrants available. And finally, make a complete and thorough check of the expiration date and the conditions, if any, of the warrants. Do you feel the stock will grow to your target price before the warrants expire? It does you no good if the stock reaches the price you projected six months after the warrants have expired.
Lastly, and perhaps most importantly, check to see what the institutions and the insiders are doing with the company's stock. Are they buying and selling? You can find this out by checking the S&P Stock Guide.
* * * * *
Simply put, a stock warrant allows you to buy a given stock for a set price at any time during the life of the warrant. When new, warrants usually run three, four, five and sometimes even ten or more years in length. Additionally, unlike with their common stock cousins, the owner has no voting rights, no say in the corporation and receives no dividends. Just the right to buy the stock at a set price during a set time period.
An example might help to explain the value of this. Let's suppose you like XYZ, Inc. Its stock is currently selling for ten dollars per share and you think it's good for twenty dollars per share in the next few years. You could simply buy a hundred shares for one thousand dollars and be done with it. If the stock goes to $20 and you sell, you've made 100%.
On the other hand, you also notice that XYZ, Inc. has warrants selling for one dollar apiece that allow you to buy shares of the company for $15 (but remember it's currently selling for $10, so the warrants are "out of the money"). But let's assume you buy the warrants anyway and the stock rises to $20 (as you thought it would) within the life of those warrants.
Your return when you sell the warrant will be four times as great. You've made 400% on the $4 rise in the value of the warrant. The mathematical bases for this - an investment concept called "parity" - comes in here. Simply put, the maximum any new buyer would ever pay for a $20 stock is obviously $20. The minimum amount any seller of a $20 stock will sell for is $20 also. Consequently, if your warrant gives you the right to buy a $20 stock for $15, the $5 difference has to show up in the value of the warrant. The warrant you bought for $1 you could now sell for $5. But nevertheless, in effect the new buyer will always pay $20 for the stock - either $20 directly in the marketplace, or $5 for the warrant and an additional $15 when exercising the warrant. The money to be made is either in buying the stock for the price ($15) the warrant allows and then selling that stock for its market value ($20), or selling the warrant for a price ($5) reflecting its increase ($4) in value. So all things being equal, parity is the invisible referee of the market place.
The biggest benefit in using warrants is - if you are correct about both the growth and the timing of the growth - you can substantially leverage your returns. (You only had to put out $1 to buy the warrant as opposed to $10 for the stock.) But the key here is the timing. If you're wrong, and the stock doesn't go higher than the exercise price before the expiration date of the warrants, then you are out of luck. The warrants expire worthless and you lose.
With the stocks themselves, a month or year may not make a difference. With warrants, this time factor is crucial. And it is the key reason to buy warrants in the first place.
So here's how to go about picking and using warrants. First and foremost, make sure you like the company you are investing in, and that careful research has convinced you it will grow.
Next, check to see if the company has warrants available. And finally, make a complete and thorough check of the expiration date and the conditions, if any, of the warrants. Do you feel the stock will grow to your target price before the warrants expire? It does you no good if the stock reaches the price you projected six months after the warrants have expired.
Lastly, and perhaps most importantly, check to see what the institutions and the insiders are doing with the company's stock. Are they buying and selling? You can find this out by checking the S&P Stock Guide.
* * * * *
posted by Bob Moser at
7:38 PM
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