Conflict of Interests: Buy the Warrant, or Buy the Shares?

All right folks, it’s time to have a talk. We’ve decided it is finally time to introduce you to the concept of warrants. Although they are not for everyone, you should be aware of them and how they work.

 

So what is a warrant?

A warrant is one form of a derivative. Think of it almost as an option. There are call warrants (bullish), and put warrants (bearish). However, for the purpose of this educational moment, we’re only focused on the bullish form. In layman terms, a warrant represents the right to buy a common share (or portion thereof) from a company. Unlike an option sold on the market, when warrants are exercised they cause dilution as the share comes directly from the company.

A warrant has two key things that investors need to be aware of:

1. The exercise price
2. The expiry date

It is these two items that essentially enable us to place a value on the warrant itself. The exercise price of the warrant enables us to know whether or not the derivative is “in the money”, i.e. its worth converting to a common share because the stock price is higher than the warrant exercise price. The expiry date is crucial, because it allows us to know when the warrant is valid until. A warrant can be exercised until the close of this trading date.

These two items, when compared to the current price per common share of the equity, is what gives us the value of the warrant. In this instance, yes time does indeed have value however it can appear to be vague sometimes. Essentially the more time until expiry, the more valuable the time premium. Be careful though as this time premium, known as Theta, decreases at an exponential rate as we get closer to expiry.

 

What’s the value in purchasing a warrant versus that of common shares?

In a word: leverage. Much like that of purchasing an option, warrants provide investors with leverage that is not available when purchasing a stock. This is due to the way in which the warrant tracks relative to the share price of its equity. Let’s look at a real world example, utilizing recently listed warrants for Newstrike Resources (TSXV: HIP, HIP.WT).

The warrants for Newstrike Resources began trading five days ago. They are the result of a recent $80 million bought deal financing that the company performed in mid February. The warrants come with an exercise price of $1.75, and an expiry of February 16, 2020. From this, we know the real value exists should the equity break through $1.75.

At the time of listing, the company opened near a recent low at $0.75. The following day it set the lowest point it has had since January 3rd. Due to the equity being so low, the only inherent value present for the warrants is time itself. Thus, when the stock was trading at a low of $0.68, the warrants were trading at a low of $0.065 per unit. This was essentially only the value of time itself.

However over the next three trading sessions, the equity put the pedal to the floor, and roared to a close of $1.12 on March 5, hitting a high of $1.15. From bottom to top, this represented a gain of 69.12%. However, in that same time frame due to the use of leverage, the warrants on the equity went from a low of $0.065, to a high of $0.17 – a gain of 161.54%. As the stock roared closer to the exercise price of the warrant, more than just the value of time was baked in to the equity.

 



Let’s stop and take a breather for a second. Consider this.

Right now, you’re likely thinking of the cash you’ll be swimming in upon buying your warrants tomorrow on open. But consider this first: it works in the inverse direction as well just as quick. Should the value of the equity decline, then the value of the warrant almost always decreases at a quicker percentage rate. It’s high risk, high reward. Therefore, it’s not for everyone. Warrants should generally be utilized when you are bullish on an equity long term.

Further to that, it requires additional capital to exchange them for shares of a company upon the date of expiry. Or worse, a forced conversion as a result of an acceleration clause which leaves you with anywhere from fifteen to thirty days typically to convert the units. There is also typically fees associated with converting units to shares as well. If you intend to only trade the warrants as a means of leveraging your potential earnings, this isn’t all that big of an issue but still is something you need to be aware of.

 

Canadian cannabis sector listed warrants

Now that you’re ready to consider warrants, here’s a gift from us to you. Be sure to do a few paper trades of warrants if you wish to utilize these derivatives. Paper trading is a valuable tool that cannot be over emphasized when utilizing a new investing method.

Below, you’ll find what is believed to be a conclusive list of currently listed warrants in the Canadian cannabis sector. It was put together via information found on SEDAR, TMX Money, and the guys over at CanadianWarrants.com. If you’re seriously considering warrants, they’re an excellent resource to further your understanding of the derivative.

If there is enough demand, we’ll establish a dedicated page for this resource and update it as required. The majority of these listing were filed in 2018, and they’re appearing at an increasing rate which is excellent for investors. We hope this helped you understand one more aspect of this complex market!

 

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Information for this analysis was found via Sedar, TMX Money, and CanadianWarrants.com. The author has no securities or affiliations related to this or any other mentioned organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security.