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SPAC Warrant Basics for Beginners

Written by Donnie Nguyen

October 14, 2020

Have you just started hearing about SPAC warrants? Perhaps you were researching TRNE SPAC on your brokerage but saw that there was a ticker symbol called TRNE+ or TRNEWS. What are those funny-looking ticker symbols? 

Those are the stock warrants for Trine Acquisition Corp, the special purpose acquisition company which is in the process of merging with 3D printing company, Desktop Metal. And depending on your brokerage, the SPAC warrant ticker symbol may differ.

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In this post and accompanying video, I cover these eleven SPAC warrant basics for beginners.

  1. Stock Warrants – A Very Brief History
  2. What is a Stock Warrant?
  3. How to Trade a Stock Warrant
  4. Stock Warrant Intrinsic Value vs Market Value
  5. When Do SPAC Warrants Become Exercisable?
  6. Exercising a Stock Warrant
  7. SPAC Warrant Expiration – Don’t Be Fooled!
  8. Cashless Exercise
  9. SPAC Unit Separation
  10. Stock Warrant Ratio
  11. Stock Warrant Risk vs Reward

#1) Stock Warrants – A Very Brief History

Stock warrants have been around for many decades. The first I heard of warrants was in Benjamin Graham’s classic book, The Intelligent Investor (the version written in the 1970s). Many wealthy investors, like Graham’s most famous student, Warren Buffett, regularly use stock warrants in multi-million dollar deals. But these days, many retailers are getting exposure to stock warrants via SPACs. SPACs often use warrants to entice investors.

#2) What is a Stock Warrant?

A stock warrant gives the holder the right to buy a particular stock at a particular price called an exercise price after the warrant becomes exercisable and until the warrant expires. We’ll go through some examples in this post, and the same examples are in the video. The details of any SPAC’s warrants can be found in its S-1 filing for free at SEC.gov.

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#3) How to Trade a Stock Warrant

To me, knowing how to trade a stock warrant is more important than knowing how to exercise a warrant, which is why I’m discussing it first. A lot of beginners get hyper-focused on exercising a warrant. Sure, you need to understand how to exercise a warrant, but selling the warrant via a trade is often a more profitable decision.

Stock warrants trade just like a stock on many brokerages. At the time of this writing, you cannot buy stock warrants on Robinhood. If you want to trade stock warrants, be sure to check with your broker first. I use TD Ameritrade and Fidelity.

Warrant ticker symbols may differ by the brokerage. For example on TD Ameritrade, a Hyliion warrant is listed as HYLN+ and on Fidelity, it’s HYLNWS. 

I always use limit orders on stock warrants to prevent price slippage. This screenshot shows an example of a stock warrant trade on TD Ameritrade using a limit order.

And here’s a screenshot from Fidelity.

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#4) Stock Warrant Intrinsic Value vs Market Value

Let’s talk about the market price of a warrant. For example, let’s say that a stock warrant has an exercise price of $11.50, which is very common for SPACs. Let’s say that the stock price went up to $21.50. That would give an intrinsic value of $10.00 for that stock warrant (21.50 minus 11.50). But the actual market price that you can trade that warrant is likely to be higher or lower than $10.00.

There’s a pricing model for stock warrants called the Black Scholes. I’ve never used Black Scholes and I never plan on using it. But here are three things you should know that affect a stock warrant’s price.

First, the expiration. The farther out the expiration, the more valuable the stock warrant. A warrant that’s expiring in five years should theoretically be worth more than a warrant that’s expiring in 30 days.

Second, is the warrant exercisable? If the warrant is not yet exercisable, theoretically it should be worth less than a warrant that is already exercisable.

And third, how popular is the underlying stock? The more popular the underlying stock is, the more valuable the stock warrant.

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Here’s an example of SHLL (Hyliion). The exercise price was $11.50 at the time that I took this screenshot. The stock price was $44.91. The intrinsic value was $33.41 but you can see that the market price was only $22.80. Why is that? 

The reason the market value was lower than the intrinsic value was that the warrant was not yet exercisable. Tortoise Acquisition Corp. and Hyliion just completed their initial business combination. So the stock warrants won’t become exercisable for 30 days after, as stated in the S1 filing.

Let’s take a look at this other example for Whole Earth Brands stock warrants. The exercise price again was $11.50. The stock price was $8.42. So the intrinsic value was negative $3.08 (8.42 minus 11.50). But the market price was $0.97 per warrant. The reason the market value was higher than the intrinsic value was that this warrant was already exercisable and it doesn’t expire for a few years. 

Here’s one reason an investor might want to buy the warrant instead of the common stock. Let’s say she wanted to buy a hundred shares of this stock. She’d be paying $842.00. But if she were to buy a hundred warrants, she’d only be paying $97.00. Let’s say a few years from now the stock price doubles. If she bought the stock she’d be up 100 percent but if she bought the warrant she could potentially be up around 450 percent, assuming the market value of the warrant was somewhere around the intrinsic value.

#5) When Do SPAC Warrants Become Exercisable

When does a SPAC warrant become exercisable? What’s typically stated in S1 filing is the later of 12 months after the SPAC IPO and at least 30 days after the initial business combination.

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M1Finance.com

So before a merger is completed, you can’t exercise a warrant. You can only trade it. That’s why it’s so important for beginners to know how to trade a stock warrant.

#6) Exercising a Stock Warrant

Now that we discussed how to trade a warrant, how do we exercise a warrant? The process of exercising a warrant may differ depending on your brokerage. It’s typically a manual process. 

You may have to call your broker or you may have to fill out a form. Your broker may charge you a commission of $20.00 or more. And the process typically takes about three to five days to exercise the warrant. Because of this manual process, you can see why I prefer to sell the warrant via a trade rather than exercising it – as long as it makes sense from a price perspective.

So let’s take a look at three examples of whether or not you should exercise a warrant. For all three examples, the exercise price is $11.50 and the stock price is $21.50. The intrinsic value is $10.00

EXAMPLE 1 – MARKET VALUE HIGHER THAN INTRINSIC VALUE

Let’s say that the market value is $12.00. Why in the world would you exercise this warrant when you could just sell it at a premium. It doesn’t make sense! You can just sell this warrant at a premium for $12.00 and if you still want to buy the stock, use the proceeds from that sale and buy the stock.

EXAMPLE 2 – MARKET VALUE HIGHER EQUAL TO INTRINSIC VALUE

Let’s say that the market value is $10.00, the same as the intrinsic value. Again, why in the world would you want to exercise the warrant? With a few clicks of a button, you can sell that warrant for $10.00 versus calling your broker or filling out a form and waiting three to five days for your broker to exercise the warrant for you. A lot of things could happen in that three to five days. The stock price could tumble over that three to five days. If you still want to buy that stock you can just sell the warrant with a few button clicks and then just use those proceeds to buy the stock with a few more button clicks.

EXAMPLE 3 – MARKET VALUE SLIGHTLY  LOWER THAN INTRINSIC VALUE

Let’s take a look at one more example. Let’s say the market value of the warrant is $9.50, or 5 percent less than the intrinsic value. Now should you exercise that warrant? Maybe. It depends.

If you exercise the warrant, it could take three to five days for you to get the delivery of that stock. And if the stock is volatile, the stock price could drop in that three to five days. So if you want to hold that stock long term and you don’t care if the stock price drops in that three to five days, then it makes sense to go ahead and exercise that warrant.

But if your main goal is to cash out of the warrant and you don’t want to risk the stock price falling over that three to five days, you might just want to sell that warrant even though it’s selling for a discount to the intrinsic value. So it’s all up to you to determine how comfortable you are with that risk.

#7) SPAC Warrant Expiration – DON’T BE FOOLED!

There are a few expirations you need to be aware of when investing in SPAC stock warrants. These are typical, but be sure to always read the S1 filing for the particular SPAC.

First, if a SPAC terminates before finding an initial business combination then the warrant will expire worthless.

Second, five years after the initial business combination, the warrant expires worthless. But don’t be fooled! Often times, the warrant will expire earlier than this five-year clause because just about all  SPACs have at least one early redemption clause.

The most common early redemption clause is if the stock is trading at or above $18.00 for 20 out of 30 trading days. If the warrant is exercisable, management can issue a 30-day written notice and redeem those warrants early. Expired warrants get redeemed at $0.01 per warrant, so basically worthless. 

So the warrant holder has three choices to make during those 30 days. He can sell the warrant, exercise the warrant, or let the warrants expire worthless. Hopefully, he won’t let the warrants expire worthless. Here’s an example from Nikola’s website when they issued their early redemption.

Some SPACs have a similar clause if the stock is trading at or above $10.00. For the $10.00 clause, there’s usually a table in the S1 filing that will give the investor an idea of what they’ll get paid if management decides to invoke this clause.

On top of all this, the company can propose a change to the terms of the warrant. I’ve only seen this in conjunction with the initial business combination.

So my point of all this is that the warrant holder needs to stay alert and can’t just set it and forget about it.

#8) Cashless Exercise

Sometimes an early redemption will be performed by what’s called a cashless exercise. In a cashless exercise, the warrant investor doesn’t have to pay the $11.50 exercise price to exercise the warrant. Instead, management lets them turn in their warrant for less than one share of common stock per warrant. For the investor, it doesn’t really matter whether they do a cashless exercise or they pay the $11.50 exercise price. The amount the investor gets is equivalent and it’s based on a standard formula.

If the company needs cash, it’s not going to do a cashless exercise. It would rather the investor give them $11.50 and they’ll distribute one share of stock. 

But sometimes it doesn’t need a lot of cash and it doesn’t want to dilute its shares. In this case, it’s better for them to do a cashless exercise so that they don’t have to create new shares to give to the warrant holders.

Here’s a cashless exercise example from Virgin Galactic’s (NASDAQ: SPCE) website when they did an early redemption.

#9) SPAC Unit Separation

SPACs usually IPO as a SPAC unit. A SPAC unit typically includes one common stock and some ratio of a warrant. 

Typically fifty-two days after the SPAC IPO, the SPAC common stock and the warrants begin to trade separately. You should be aware of the unit to warrant ratio, which is listed in the S1 filing. The unit to warrant ratio is usually one half or less of a warrant (e.g. one half, one third, one fourth, etc.). 

As an example, if the unit to warrant ratio is one fourth, you need to have four units to get one warrant. So if you decide to buy these units and separate them out you’ll need to buy these units in multiples of four in order to get one warrant for every four units.

Sometimes the units will have an automatic separation and sometimes a manual separation. Your brokerage may charge you what’s called a reorganization fee in order to separate out the units. This fee will apply whether it’s an automatic or manual separation. If you do get charged this fee, your brokerage may be willing to reimburse it if you give them a call.

#10) Stock Warrant Ratio

Most SPACs have a warrant ratio of one to one. That means that you exercise one warrant for one common stock. But the warrant ratio may be less than one to one. For example, if the warrant ratio were one to one half that means you need to exercise two warrants for one common stock. It’s not something I see often but it is something to be aware of.

#11) Stock Warrant Risk vs Reward

We already discussed some of these risks above, but I want to re-emphasize them here.

First, warrants can expire worthless.

Second, warrants, like a common stock can lose their value. But warrants are typically more volatile than common stock. It’s not uncommon for a warrant to lose more than 20 percent of its value in a day.

Given the risk, why would someone want to invest in the SPAC warrant over the common stock? Let me demonstrate with an example.

Let’s say the investor bought the stock at ten dollars. If the stock goes to twenty dollars, the investor makes a hundred percent return on her investment. 

But let’s say instead of the common stock, she bought the warrant for a dollar. If the common goes to twenty dollars, the intrinsic value of the warrant is eight dollars and fifty cents ($20 minus $11.50). For this example, let’s just say that the market value is also $8.50. So her warrant’s return on investment in this example was 750 percent.

This is why I often prefer to invest in the SPAC warrant rather than the common stock.

THE BOTTOM LINE

Stock warrants can be an interesting investment for one’s portfolio. When investing in warrants, it’s important to understand the mechanics and risks involved. I hope that you enjoyed this post. If you have any questions or comments, leave them below. Feel free to share this post with someone you think would enjoy reading it.

What to learn the principles that help me to consistently beat the market? Check out my free eBook, 5 Things I Wish I Knew Before Buying My First Stock. 

DISCLAIMER: I'm not a financial advisor. These are my opinions and provided "as-is". It is not an offer to buy or sell securities. Read the Terms and Conditions.

Disclosure

I/we own shares of HYLN, TRNE warrants

Except for Wolves of Investing, I/we are not receiving any compensation from and do not have any business dealings with any companies whose stocks are discussed in this article.

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Donnie Nguyen

Donnie Nguyen

Donnie Nguyen is the founder and CEO of Wolves of Investing. He started investing in the stock market in the early 2000s. He follows the teachings of Peter Lynch, Warren Buffett, and other investing legends. When he's not investing or blogging, he loves spending time with his family traveling and experiencing the world.

Follow Donnie on Facebook and Twitter!

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