Warrants

What Are Warrants?

Warrants are securities issued by a company that give the holder the right to purchase the company's stock at a specified price (the exercise price) before a specified expiration date. They are functionally similar to call options but with critical structural differences: warrants are issued by the company (not created by market participants), have longer durations (often 3-10 years), and result in new share issuance when exercised (diluting existing shareholders).

Warrants became familiar to retail investors through the SPAC boom of 2020-2021, where every SPAC unit included fractional warrants alongside common shares.

Why Warrants Matter

Warrants are significant for several reasons:

• Dilution impact: When warrants are exercised, new shares are created, diluting existing shareholders. A company with 100M shares outstanding and 20M warrants faces potential 20% dilution. This overhang can depress the stock price and must be factored into valuation
• Leverage instrument: Warrants trade at a fraction of the stock price and provide leveraged exposure to upside. A warrant with a $10 exercise price on a $15 stock might trade at $6, rising to $10 if the stock reaches $20 (67% gain on warrant vs. 33% on stock)
• SPAC dynamics: SPAC warrants create unique trading dynamics. They typically become exercisable 30 days after the de-SPAC transaction and can be called by the company if the stock exceeds $18 for 20 of 30 trading days

Evaluating Warrants

When analyzing warrants, key factors include:

• Exercise price: The price at which the warrant can be converted to stock. Compare to the current stock price to assess the required appreciation
• Expiration date: Longer durations provide more time for the investment thesis to materialize
• Dilution: Calculate the fully diluted share count (existing shares + all warrants) and the impact on per-share metrics
• Redemption provisions: Many warrants include provisions allowing the company to force early exercise (call the warrants) if the stock exceeds certain price thresholds. This caps the upside for warrant holders
• Liquidity: Many warrants trade with wide bid-ask spreads and low volume, making entry and exit expensive

Warrants are best suited for investors with high conviction in a company's long-term appreciation who want leveraged exposure with a defined maximum loss. The long time horizons reduce the time decay pressure that makes short-dated options challenging.