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I'm looking at a specific (American-style) warrant of a company and let's say I see something like the following:

  • Warrant Bid/Ask: 0.30$/0.35$
  • Strike Price: 15$
  • Current stock price: 16$
  • Expiration date: 21st of December of 2018

How is this possible? This implies I could buy these warrants and sell immediately earning a profit of (16$ - (15$ + 0.35$)) = 0.65$ which seems ludicrous.

I understand that the value of the stock might go down when I exercise the warrant, but still it seems unlikely that the stock will fall more than 0.65$ if I just buy a few hundreds shares.

So, what's wrong here?

  • Including a specific link to the instrument you are looking at could help someone identify where the difference lies. – Grade 'Eh' Bacon Jun 26 '17 at 15:10
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    It's also possible that the quotes are old (prior trade prices) and don't reflect current market based on stock price. – D Stanley Jun 26 '17 at 15:30
  • And you are correct, the stock price is not going to down 4% just due to the dilution from the new shares. – D Stanley Jun 26 '17 at 15:32
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    I answered generally, but if you could cite your specific example, we can perhaps shine a light on the specific reason for the perceived mispricing. – Chris W. Rea Jun 26 '17 at 17:12
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    You will likely find that it is impossible to buy the warrant for that price, and that the last sale happened when the share price was a lot lower. – gnasher729 Nov 19 '17 at 18:51
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While on the surface it may seem that the warrant you described is trading below intrinsic value, there are many reasons why that might not be the case. It's more likely that you are lacking information, than having identified a derivative instrument that the market has failed to reasonably price.

For instance, might there be a conversion ratio on the warrants other than the 1:1 ratio that you seem to be assuming? Sometimes, warrant terms are such that multiple warrants are required to buy one share of stock. Consider:

The conversion ratio is the number of warrants needed in order to buy (or sell) one investment unit. Therefore, if the conversion ratio to buy stock XYZ is 3:1, this means that the holder needs three warrants in order to purchase one share. Usually, if the conversion ratio is high, the price of the share will be low, and vice versa. (source)

Conversion ratios are sometimes used so that warrants can be issued on a 1:1 basis to existing stockholders, but where the potential number of new shares to be issued is much less.

Conversion ratio is just one such example that could lead to perceived mispricing, and there may be other restrictions on exercise. Warrants are not issued by an options exchange using standardized option contract terms, and so warrant terms vary considerably from issuer to issuer. Even series of warrants from the same issuer may have differing terms.

Always look beyond any warrant quote to find a definitive source of the warrant's precise terms — and read those terms carefully before taking any position.

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