Warrants - Like LEAPs But Better

Includes: BAC, GM, JPM
by: Adam Jones

LEAPs have historically been the best way to get long term exposure to stocks without actually buying the stocks themselves. A new vehicle for this exposure was created when the government bailed out many companies during the financial crisis. As a part of some of those bailouts, the government was given warrants that expire in the 2016-2019 time frame. These warrants have since been sold off by the government and are now publicly traded.

These warrants provide a range of benefits over LEAPs for investors trying to get low cost leveraged exposure to companies over a long time period.

Longer Time Frames

The most obvious benefit of these instruments is their longer times till expiration than LEAPs. For example, the GM (GM) Series B warrants and the Bank of America (BAC) Series A warrants expire in 2019 while the JP Morgan (JPM) warrants expire in 2018.

The longest dated LEAPs expire in January 2015, so the warrants provide an additional 3 to 4 years of exposure in one product.


Another big benefit of the warrants is the liquidity and flexibility available in the product. The GM Series B warrants have a strike price of $18.33. The closest LEAP, the Jan. 2015 $18 call has a total open interest of 1,130 and less than 20 of them trade in an average day. Also, the spread between the bid and the ask is around $0.15. The warrant's average daily volume is around 400,000 contracts while the spread between the bid and the ask is generally below $0.07. This means it is cheaper and easier for investors to buy and sell these instruments.

Also, each warrant provides the right to buy one individual share at the specified price. The LEAPs provide the right to buy 100 shares at the specified price. For investors who like to step into positions or who trade in smaller denominations than 100 shares, the flexibility to buy exposure to individual shares is very helpful.

Dividend Adjustment

These warrants provide dividend protection that is not available for LEAPs. As the dividend for the common stock rises above a specified threshold, the strike price is adjusted down by that amount. For the Bank of America Series A warrants, the dividend threshold is $0.01 per quarter. That means that if the quarterly dividend is $0.05 per share, each dividend paid will reduce the strike price of the warrants by $0.04. This continual reduction in strike price can have a meaningful impact over 6 years. The current dividends of both Bank of America and JP Morgan are at the adjustment threshold. That means that any increase in dividends paid begins to reduce the strike price of the warrants.

The warrants in each of these three companies provide compelling investments going forward. The GM Series A, GM Series B, and JP Morgan warrants are essentially deep-in-the-money calls - but better. The Bank of America Series A and Series B warrants are out-of-the-money calls - but better.

Disclosure: I am long JPM, BAC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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