How to Determine a Warrant Premium

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Stock warrants are derivative securities very similar to stock options. A warrant confers the right to buy (or sell) shares of a company at a specified strike price, but the warrant owner has no obligation to actually buy (or sell) the stock. Pricing is also similar to options. A warrant buyer pays the difference between the strike price and the current market value (called intrinsic value) plus a premium. However, it's more complicated to determine a warrant premium because it usually takes more than one warrant to purchase one share of stock. Warrants don't follow a standardized contract. Instead, stock warrants are issued by corporations, usually as an inducement to purchase another security such as preferred stocks or bonds.

Things You'll Need

  • Calculator
  • Current market prices
  • Warrant terms
  • Find the conversion ratio of the warrant. The conversion ratio tells you how many warrant certificates are required to purchase each share of the stock. For instance, if the conversion ratio is 4:1, you will need 4 warrants per share. You can find the conversion ratio on the warrant certificate. You can also ask your broker about a particular warrant issue or contact the company's Shareholder Services (contact information will be on their Investor Relations website).

  • Multiply the current market price of one warrant by the conversion ratio to find the cost of warrants sufficient to purchase one share of the stock. For instance, if the conversion ratio is 4:1 and the warrant's market price is $5.25, the cost for the 4 warrants needed per share is $21.00.

  • Subtract the strike price of the warrant from the current market price of the stock. This is the intrinsic value of the warrant. Suppose the strike price is $25/share and the current price is $45/share. The intrinsic value is $45 minus $25 or $20/share.

  • Subtract the intrinsic value (from Step 3) from the cost of the warrants (from Step 2). The remainder is the warrant premium. If the cost of the warrants is $21 and the intrinsic value is $20, the warrant premium is $21 minus $20 or $1.00/share.

Tips & Warnings

  • Warrants are issued as certificates. The terms and conditions of the warrant are stated on the certificate.
  • Warrants offer high profit potential because they are leveraged just as options are. However, they also carry high risk. If the stock's market price isn't greater than the strike price, the warrant has no value.

References

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