Traditional corporate equity warrants

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9. Basic analysis

Warrant prices are linked to the prices of the underlying shares. But the exact nature of the link is sometimes difficult to fathom, and the link is not always a strong link. So, although there is a relationship, shares and warrants trade independently, and at any one time may have different factors influencing their respective prices. A share may be deemed to be good value, but that doesn't necessarily make the warrant also good value.

The following section on analysis presents a set of tools for studying warrants, including the analysis of their relationship with the underlying shares. In the course of which, the section tries to answer questions like -

• How much will a warrant be worth at expiry?
• Is this warrant cheap?
• Which of these two warrants is better to buy?
• Should I buy the warrant or share?
• What will happen to the warrant price if the underlying equity increases 20%?

A dangerous attraction of warrants is that they commonly have low prices - quite a few warrants are priced under 2p. The problem here is that it attracts a 'penny share mentality', which equates cheap price with cheap value. But there is often a good reason for the very low prices - the good chance that the warrant will expire worthless! And regarding the old canard that cheap securities can double in price easier than higher priced securities (i.e. a move from 1p to 2p is easier than from 50p to 100p), a quick look at the enormous bid-offer spread on low priced warrants should scotch that idea.

It is therefore important to properly analyse warrants, to distinguish the genuinely cheap from the expensive.

The analysis of warrants is made somewhat easier as there is no income attached to warrants. It is pure capital gain - so no complicated yield calculations. Hurrah! Against that, the analysis is made fiddly as warrant terms are not generally standardised. Fortunately, we now have computers and spreadsheets, which makes much of this analysis quite simple.

1. Introduction 2. What is a warrant? 3. The warrant market 4. Advantages of warrants over shares - the magic of gearing 5. Further attractions of warrants 6. Disadvantages of warrants 7. Fundamentals - warrant terms 8. Fundamentals - intrinsic value and parity ratio 9. Basic analysis 10. Analysis - time value and premium 11. Analysis - gearing 12. Analysis - break-even and capital fulcrum point 13. Analysis -sample spreadsheets 14. Analysis - summary 15. Investing strategies 16. Dealing in warrants 17. Warrant exercise 18. Further topics 19. Further information 20. Conclusion

• Andrew McHattie on Covered Warrants