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Summary

  • JPMorgan is expected to announce a quarterly dividend of $0.41 or $0.42 within weeks.
  • The raised dividend amount will be above the adjustment threshold for the JPMorgan warrants.
  • The expected dividend will reduce the strike price of the warrants each time it is paid.

During the JPMorgan (NYSE:JPM) investor day in early March, Jamie Dimon hinted the company will likely raise the common stock dividend soon. Several firms are expecting a dividend increase from JPM to between $0.41 and $0.42 per quarter when CCAR results are announced in late March.

This dividend increase will bring the dividend above the quarterly adjustment threshold for the warrants that trade on JPM. Here's an introduction to warrants if you are not familiar with them.

The table below shows the relevant information for the warrants with relation to the current stock price.

JP Morgan Warrant (JPM-WT)

Warrant Strike Price

$42.42

Warrant Price

$19.78

Warrant Exp. Date

10/28/2018

Time until expiration (years)

4.64

Current Stock Price

$59.40

Current Warrant Break-even Price at Expiration

$62.20

Stock CAGR Required for Warrants to Break Even at Expiration

1.70%

There is currently a very low premium priced into the warrants therefore the stock only needs to appreciate just under 2% per year for the warrants to break even by expiration in just over 4.5 years. The warrants present a great low premium and leveraged way to gain long term exposure to the stock.

Warrant Strike Price Adjustment

As discussed in the JPM warrant prospectus, if the dividend paid to common stock holders exceeds $0.38 in any quarter, the strike price of the warrants will be adjusted downward. In addition the number of shares of common stock each warrant holder is entitled to will increase. To better understand the warrant adjustment process outlined in the prospectus, here's the adjustment mechanism in equation form.

(click to enlarge)

In words, the strike price is adjusted downward by the percentage the stock yields excluding the portion of the dividend that is under the threshold.

As an example of this calculation, let's assume JPM closes at $60 per share the day before the ex-dividend date with a dividend of $0.42 to be paid. The new warrant strike price is calculated below.

So given the constraints noted above, the strike price of the warrants drops by $0.02 after the dividend.

Number of Shares Adjustment

There is a second adjustment, which is made to the warrants. The number of shares each warrant can purchase increases each time the warrant strike is adjusted downward. When the warrants were initially issued, each warrant represented the right to purchase 1.00 common share of stock. This number changes however, because each time the warrant price drops, the number of shares each warrant is entitled to is multiplied by the ratio of the old warrant price to the new warrant price. This is shown below in equation form:

Rounded previous warrant shares are the number of warrant shares rounded down to the nearest 0.1. Note that this is not exactly how the prospectus is worded - but it is how the adjustment is actually calculated for the Hartford Group warrants, which are currently being adjusted and have the same adjustment mechanism. I expect the JPM warrants will utilize the same methodology.

Using the same example values as before, the change in warrant shares is calculated below.

This could be a very beneficial adjustment for anyone holding warrants because it increases the ownership in the company. However since the added number of shares is so small, the benefit will be relatively minimal. Rounding the new number warrant shares (1.00047) down to the nearest 0.1 means that warrant holders will continue to only own 1.0 share of common stock until the new number is greater than 1.1 or the warrants are exercised.

To help illustrate this, the number of warrant shares is calculated below for a second dividend payment using the same criteria above.

Even though 1.00047 is used as the "previous number of warrant shares", because it is less than 1.1, the rounded warrant shares stays at 1.0.

From the equations above, to estimate the total future adjustment, the dividend paid and the closing price of stock when the dividend is paid need to be known value. This makes it very difficult to extrapolate how much the dividend will affect the warrants long term.

Here is an estimate of how the warrants would be adjusted if JPM were to simply keep a dividend of $0.42 per quarter between now and expiration of the warrants (roughly 19 dividends paid) with a constant $60 share price. This is a pretty basic scenario, I know. In this scenario, the warrant strike price would adjust downward by a total of $0.38 to $42.04 and the warrant shares would still not increase above 1.1, so each warrant would represent roughly 1.001 shares of stock. For comparison, if you held the common stock over the same time period, you would receive $7.98 in total dividends.

If you use the strike price from the scenario above ($42.04) in calculating the premium in the warrants, they are trading at a break-even stock price of $61.82, only 4% above current levels. This is a very small amount of premium for roughly 3:1 leverage for 4 ½ years which makes the JPM warrants look cheap as a way to gain long term exposure for lower premium.

The very complicated nature of warrant adjustments has left the value of these adjustments under-appreciated. They make relatively small differences in the value of the warrants - but they do make the cheap JPM warrants look a little bit cheaper.

Source: JPMorgan's Impending Dividend Increase - What Does It Mean For The Warrants?

Additional disclosure: I am long the JP Morgan warrants discussed in this article.