What is a Warrant Premium?
A warrant premium is the difference between the current traded price of a warrant and its minimum value. A warrant’s minimum value is the difference between its exercise price and the current traded price of its underlying stock. Alternatively, a warrant premium is the percentage difference between the cost of purchasing shares by exercising a warrant and buying them in the open market at the current price.
Key Takeaways
- A warrant premium represents the additional value of a warrant above its stated minimum, estimated as the difference between its strike price and the market price of the underlying.
- It also refers to the premium given to exercising a warrant over buying shares in the open market.
- A warrant is a type of call option granted by companies that provides the right to purchase company shares in the future under favorable terms.
Dive Deeper: Understanding a Warrant Premium
Warrants possess both a price and a premium. Generally, the premium reduces as the warrant price rises, especially as the expiration time decreases. When a warrant is ‘in-the-money’ (ITM), the exercise price is below the current share price; the deeper it is ITM, the lower the premium will be. Nonetheless, high volatility can increase the warrant premium.
Just like call options, the warrant premium can fluctuate based on supply and demand factors.
Mastering the Math: Calculating the Warrant Premium
The warrant premium can be derived by the following simple calculation:
- Premium = current price of the warrant - minimum value
- Minimum value = exercise price - current price of the underlying stock
Example of Warrant Premium
Let’s say the warrant price is $10, the exercise price is $25, and the current share price is $30. The warrant premium would then be calculated as:
$10 - ($30 - $25) = $5.
For the percentage calculation:
- Premium (%) = [(Warrant Price + Exercise Price - Current Share Price) / Current Share Price] * 100*
Using the numbers from above:
[( $10 + $25 - $30) / $30] * 100 = 16.7%
Warrants typically trade at premiums because traders anticipate an increase in the underlying stock’s price. As with all options, this premium dwindles as the expiration date nears.
Comparative Analysis: Difference Between Options and Warrants
A warrant shares similarities with a call option by giving the owner the right, but not the obligation, to buy an underlying security at a determined price and time. However, a warrant is issued by a company, unlike an option, which is a stock exchange instrument. The security suspended in a warrant, usually share equity, is delivered by the issuing company instead of by another investor holding the shares. Meanwhile, traders are not authorized to write warrants.
Companies frequently append warrants to new security issuances to entice investors into buying. While listed options usually have a maximum expiration of one to three years, warrants often have expirations extending up to 15 years or more.
From Stock to Warrant: How Do Warrants Differ From Company Stock?
Companies occasionally grant warrants as a form of equity compensation to employees, known as employee stock options (ESO). Despite being option contracts, they do not pay dividends nor provide voting rights until they are exercised and converted into shares.
Sweet Investments: What is a Warrant Sweetener?
Companies might attach warrants to other issued securities to raise capital by making the offering more compelling to investors. An example of such a sweetener could be attaching warrants to corporate bonds or preferred shares. This practice is known as a sweetener.
Protect Your Investments: How Can Warrants Dilute Earnings Per Share (EPS)?
Earnings per share (EPS) is a significant metric observed by investors and analysts. It is calculated by dividing a company’s net income over a certain period by the number of shares outstanding. Warrants have a potentially dilutive effect since they represent prospective new shares not currently available. As a result, fully-diluted EPS accounts for all new possible shares, including those from warrants, employee stock compensation, and convertible securities, thereby offering a more comprehensive picture to investors.
Invest responsibly; consult a financial advisor for personalized advice.
Related Terms: Stock Options, Intrinsic Value, Exercise Price, Call Options, Diluted EPS.
