Warrants Explored: Are They As Good A Value As Some Think Or A Miscalculated Option?

Includes: BAC, C
by: Ron Reed

There's been a bit of a buzz about warrants of late, and I'd like to take the time to look a little closer at them with you. For starters, a stock warrant is in many cases similar to a long dated call option.

A call option is a contract to buy (or sell if you are selling the call) a given security at a certain price (called the strike price) between the date bought (or sold) and the expiration date (called American style; European style can only be exercised on the expiration date).

For example, an American style June 16th 2012 call option with a strike of 10.00 on ABC stock can be exercised and allow the call holder to purchase ABC stock for 10.00 a share, regardless of what the market price is. Stock options have various dates for expiration, but generally speaking only go out as far as two years.

Based on current market date (May 30th 2012), our fictitious company ABC would likely have options expiring in June, July, August, September, October, November, and December of 2012, and then two long dated options referred to as LEAPS with January 2013 and January 2014. Stock warrants operate quite similar in that they have a style (American or European), a strike price, and an expiration date. They tend to have much longer expiration dates and several other additions that we'll discuss.

While options have round number or 1/2 dollar strikes ($1.00, $2.00, $3.50, etc...) and various expiration dates, Warrants tend to have only one expiration date and one strike price, and often the strike price is not a round dollar or 1/2 dollar number. They also have conditions on the dividend that options do not carry. Most warrants tie the strike to a certain threshold of dividend.

For example, our ABC warrant may have the threshold set to $0.10 dividend. Thus, if the company declares a dividend over $0.10 per share then that price is deducted from the strike each time it happens. The strike, EX date, and dividend threshold strike readjustment are all given for each particular warrant in its prospectus. Finding that published data is not easy on your own, you can certainly search the SEC website to find it, but it is not easy. The fastest way to get at it is the shoot an e-mail to the company in question's investor relations department. I'll include links to the Prospectus at the end of the article.

The first warrant I'd like to look at is the Citigroup (NYSE:C) class A (C+A) and Class B (C+B). You may need to do a company name search to get them to come up, as certain companies list the ticker a little different from one another. Yahoo lists them as C-WTA and C-WTB, whereas TDAmeritrade lists them as C+A and C+B. Just select the look-up ticker by name and type in the main company name and search and look at all returns that have that name. You'll find some other premium stocks and other assets that are available this way as well.


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Citigroup Class A warrants trade at $0.35 and the Class B at $0.07 as of 30 May 2012. While that low price looks great, and many folks are pushing them, they are terrible in my opinion. A few things need to be kept in mind when looking at them. #1 Citigroup is trading at $26.15 the strike for the warrant is $106.10 for the Class A and $178.50 for the Class B. The Class A has a dividend threshold of $0.01 and the Class B has a dividend threshold of $0.16. Each warrant is worth 1/10 of a share due to the reverse split that occurred on May 19 2011. So at the going rate, you would have to spend 35.00 on the premium to gain the option to buy the stock at 106.10 per share between now and Jan 4 2019. Not good odds at all.

You would have to have the company's stock price grow more than 520% just to break even (not counting the paltry $0.04 per share per year dividend). The Class B would need to see 687% growth in the stock price to break even and would need to see at least a quadruple in dividend to even take any effect on the strike. Both warrants are exercisable at any time before expiration

Bank Of America (NYSE:BAC), on the other hand, has some Class A and Class B warrants that appear to be a great value even in the depressed market the whole banking sector finds itself (and appears to grow more unstable in the near future). The BAC Class A (EX 16 Jan 2019)(BAC+A) warrants carry a $13.30 strike price and $0.01 dividend threshold. The current market price for the warrant is $3.29 and each warrant carries a full share of stock.

Bank Of America is currently trading at $7.25. So to realize a breakeven point at current prices, you'd need to only see a 223% increase in stock price (again not counting in the paltry $0.04 per year dividend). This is a fully attainable goal for even the lower risk profile investor. The BAC Class B Warrants (EX 28 OCT 2018) are trading at $0.74 each, carry a $30.79 strike, $0.32 dividend threshold, you would need to see a 434% increase in the share price to reach the breakeven point. Both are exercisable at any time before expiration.




To be fair, both companies are trading close to the 52-week lows, BAC was recently at 10.00 back in April, which at that time the class A warrant was trading at 5.30, still only a 189% increase to reach the break even point. Citigroup on the other hand was 38.39 and the Class A warrant at $0.46 requiring a (276%) increase to break even.

I see a lot of ink on the Citigroup warrants being a great value, and while they may turn out to be a windfall, I don't see a lot of value to them with the strike price so high and carrying the 1:10 dilution. There are a lot of ways to value these warrants and many attempt to use the Black-Scholes algorithm (often used for options) however, with the long dated expiration it is rather useless to try and value them using it.

The IV (Implied Volatility) values cannot be properly taken into account since they are so far dated, and the historical volatility values are so slanted by the crash and the European debt debacle that they cannot be used with much reliability. The best way to value them is to value the stock itself and simply consider the warrant price to be all time value and nothing else. The relative values then work much easier and much more accurate for such long-termed options. As we get closer to the EX date, they will tend to move more like options, but for now do not behave with the same volatility.

The best value I see is the Bank Of America Class A Warrants. A steal at $3.29 for, in effect, a 6-1/2 year option. Just like options, there is a liquid market for the Warrants as well, so they can be used both as a hedging tool as well as investment or speculation tool. Just like options, they do hold different risk than straight stock plays that need to be understood and considered before investing. Just for consideration if we were to use the current numbers and the Black-Scholes formula, the current IV would be 65%. Since volatility is a moving target, there are two ways mainly used to express it: Historical and Implied. Implied Volatility is a back calculation using the Black-Shoals formula.

Link to BAC Class A Warrant Prospectus:


Link to BAC Class B Warrant Prospectus:


I am long both C and BAC, as well as BAC Class A and Class B warrants.

Disclosure: I am long C, BAC.