This article offers a tutorial on warrants as an underused investment vehicle, disabuses myths about warrants, shares the names of some warrants that warrant attention and makes the case for adding warrants to one’s portfolio.
The comments above and below are excerpts from an interview of Dudley Baker (CommonStockWarrants.com) by Brian Sylvestor (GoldReport.com) as posted on SeekingAlpha.com under the title Warrants Warrant More Respect In the Resource Sector which has been enhanced – edited ([ ]) and abridged (…) – by munKNEE.com (Your Key to Making Money!) to provide you with a faster & easier read. Register to receive our bi-weekly Market Intelligence Report newsletter (see sample here , sign up in top right hand corner.)
The Gold Report: Before we get into how to invest in warrants, please tell our readers what a warrant is.
Dudley Baker: Very simply, a warrant is a security that gives the holder the right, but not the obligation, to purchase the underlying common shares at a specific price and includes a specific expiration date.
TGR: How does that differ from a futures contract?
DB: A futures contract refers to the purchase of an actual commodity: gold, silver, soybeans, pork bellies, etc. Warrants also differ from call options. Those are derivative contracts written on a stock, stock index or futures contract. The official definition of warrants states that they are securities, the distinction being here that a warrant is actually issued by the company.…
TGR: …Does market performance have an effect on the warrant market?
DB: Yes, if stocks are down, warrants will be down. That said, it’s all about the underlying company. For the warrant to do well, the company has to perform… [and warrants often provide twice the returns of the associated stock and the longer term the warrants are the greater the chance of such occurring.]
TGR: Why do mining companies, especially gold and silver equities, deal in warrants more than other sectors?
DB: The resource sector is highly capital intensive and high risk. Let’s face it, the companies need more incentive to get someone like Rick Rule and Sprott Global involved in a potential financing. They have to offer a long-term warrant as an equity kicker…
TGR: What’s the typical path to making money by investing in a warrant?
DB: The most straightforward, logical way is to pick the right company and buy its warrants. If the company doesn’t perform, the warrant can’t perform either…[and we also] need a good market environment or the expectation of a good market environment…
TGR: Are there other ways to make money with warrants?
DB: …An investor…could
- split his investment between the stock and the warrant depending on the leverage situation…according to the investor’s risk/reward ratio or
- hedge positions and
- buy the warrants and short the common shares…or
- buy the warrants and sell puts against that position….or
- short the warrants and buy call options.
…[Hedging] works better in the U.S. markets…because American investors can’t exercise a warrant issued in Canada; U.S. investors can only trade Canadian warrants…
I’d almost say, especially in the U.S., any time you are doing a hedge and you’re buying the common shares as your core position, basically you just substitute the company’s long-term warrant for the common shares, and you can accomplish that same hedge position with a lot less cash on the line, which means your net return will be substantially higher.
TGR: What are four things should investors be aware of before entering the world of warrants?
- [Keep in mind that] warrants can expire and once they’ve expired, they are worthless. I would recommend choosing only long-term warrants, which to me means a minimum of two or three years. This gives you more time for the markets to turn around and to capture the maximum gains.
- [Choose only]…companies [where] you like [the fundamentals and believe in the potential prospects] you like…
- …Determine what the warrants’ current leverages are [and whether they are] overpriced, fairly priced or undervalued. You don’t want to pay more than you have to.
- The liquidity of warrants as they vary on a daily basis.
TGR: When you talked with The Gold Report in 2008, there was no exchange where warrants were traded. Are there some new resources that make warrants trading more transparent and, perhaps, simpler?
DB: The lack of information about warrants was one reason I started my service back in 2005 but there has been considerable progress since then. Today, warrants are traded like stocks on the Toronto Stock Exchange [TSX] and the TSX Venture Exchange [TSX.V] in Canada and warrants for U.S. companies can trade on the New York Stock Exchange [NSYE] or on NASDAQ. Exchanges issue warrants a symbol usually with a .WT suffix in Canada & perhaps a -WS suffix or five letters in the U.S., just like common shares…
TGR: When an outstanding warrant is worth less than the current stock trading price, it can create an overhang on a stock. How do you play that situation?
DB: True, there will be slight dilution to the company’s shares, if and when those warrants are exercised, but that means new cash coming into the company’s kitty so we see it as a tradeoff….
TGR: What’s the best way to play a long-term warrant?
DB: If you own a warrant and, after 6 to 12 months, decide that the common shares have peaked and are overbought, you sell the warrant at the same time that you would sell the shares. You make the same decision, as though you owned the common shares. You don’t have to hold the warrant until the expiration date….Warrants are totally liquid. You can buy today, sell tomorrow. You’re not locked in.
TGR: …[When you] buy warrants do you then sell them when you believe they are appropriately valued?
DB: Exactly. I would be utilizing all the tools that an investor would: looking at long-term charts, following analysts or newsletter writers [and] if, as I expect, we get a nice bull market in the resource sector, it would not be uncommon to see common share prices double, triple or quadruple. The warrants should do twice as well. It’s just a matter of staying on board as long as possible to capture these gains, but knowing that you can pull the plug and can exit at any moment. It’s like any investment, if you double your money, you may want to take some money off the table and minimize your risk.
TGR: If investors want to find the current value of …[certain] warrants that are trading, where would they go?
DB: That’s the dilemma for most investors. There are over 200 warrants trading on the markets now in total, not just in the resource sector. It’s tooting my own horn, but CommonStockWarrants.com is virtually the only place to find all the detail needed to make informed investment decisions. Barring that, investors willing to invest the time can follow company news…
TGR: What would be one final thought for our readers?
DB: Warrants are a simple investment vehicle that has been overlooked for decades, whether for trading or for hedging….
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