hdt@sunybcs.UUCP (Howard D. Trachtman) (03/17/84)
. .. ... Bits for the buggy machine's bit bucket.
I got a lot of mail about this, so I'm posting to the network.
First of all let met expain what warrents and rights are.
Suppose ABC Corp. is trading at $25 a share and would like to increase
their capitalization (number of shares outstanding) but doesn't want
to issue the stock right away as it would probably lower the price
of the stock and dilute the earnings right away. The company may then
issue a WARRENT to purchase its stock. The warrent will have an
EXERCISE PRICE and an EXPIRATION date. The exercise price is the price
that one must pay to purchase additional shares of stock. For example,
lets assume the exercise price is the same as the market price, $25
a share. What this means is that if you owned the warrent you could
send the company $25 and get one share of stock for each warrent (very
rarely companies issue warrents which are convertible into a different
number of shares/warrent). However, there is a catch, the warrent must
be exercised (the physical process of delivering the warrent plus money
to a broker/transfer agent) before the expiration date. A right is
the same thing as a warrent except that they are only valid for a
shorter period of time (usually under 6 months) while warrents usually
last several years (some are even perpetual; they never expire).
How much is a warrent worth? Well, the price is determined by the
market and usually depends on the volitility of the underlying stock.
The other major factor is the time element left. In my example, a
1 year warrent might trade for $4 and a 5 year warrent for $7.50
Some people have written books with a lot of mathematical formulas
for determining the "expected" worth of a warrent. The reason
the premium is so high is the leverage available. If the stock
were to double, it would be worth $50 a share and the warrent would
have an inherent worth of $25 a share, which is an incredible profit.
However, if the price were to stay the same or go down, the warrent
would become worthless. There are two other advantages in purchasing
warrents. One is the limited liability feature. If you purchase 100
warrents and the company were to go bankrupt, all you would lose
would be your original purchase price, in the example $400. If you
were to purchase the stock you would lose $2500. The other factor
is that you can control more shares of stock (this is more useful
for options). By this I mean you could buy over 600 shares worth
of warrents for the cost of 100. You could only vote the stock if
you were to actually exercise the warrents. Warrents trade on the
exchange just like regular stocks. You can get a quote on a warrent
on a quote machine by typing the symbol name followed by .WS in
my example this would be ABC.WS
A call option is just like a warrent except they may be sold by
almost anyone, not just the company. They trade on the Chicago,
American, Philadelphia and Pacific exchanges. While warrents only
exist on a handful of stocks, listed options trade on virtually
every high volume stock including some on the OTC/NASDAQ.
A call option has a STRIKE PRICE (the amount of money you would
have to pay to exercise the option) and an expiration date.
Every listed option has 4 months that its options trade in,
of which only 3 will trade at a given time. Each of these months
are 3 months apart. For example, IBM options trade currently for
the April, July, and the October months. The strike prices that
trade are based on a complicated algorithm based on the recent
prices of a stock, and are generally in multiples of 10 for
lower priced stocks. Exceptions occur when a stock splits.
Options generally expire 3PM of the 3rd Friday of the month,
but it is important to notify your broker long before that time
to either sell or exercise your options. You should always try
to do one or the other as the otherwise your options expire worthess.
It's not uncommon for options 3-5 points out of the money (see below)
to actually trade for 1/16 on the expiration date.
The buyer of a call option expects the stock to go up, and his
profit or loss (except for commissions) will be the price of
the stock on the day the option is sold minus the strike price
minus the original cost of the option plus any time value the
option may have. For example, today we buy a July IBM 100 call
option for 11 points ($1100). IBM is 103 (I'm making this up,
I don't know what IBM is today). 8 points (100+11-103) is called
the PREMIUM that one pays. The 3 points (103-100) are said to
be points IN THE MONEY. If instead the option had a strike price
or 110, the option would be said to be 7 (110-103) points
OUT OF THE MONEY.
A put option is the opposite of a call option. It gives the owner
the right to sell a stock at a particular price. Purchasing one
will enable one to make a profit if the price of the underlying
stock goes down. For some reason put options trade at a
relatively small premium relative to call options and thus are
recommended over short selling. The terminology is much the
same: a 100 strike put with the underlying stock at 105 is said
to be 5 points OUT of the money.
All options trade in multiples of 1/16 of a point. For options
under 5, you might as well put in a bid that includes a multiple
of 1/16 if you wish. Over 5, this is not some common. Because
an option can only trade at 1/16 and no lower, I frequently
recommend buying options that are out of the money at 1/16 if
they have significant time left in them. Your only risk is
your commissions (which should be no more than $35 for 64 options
at 1/16 with a discounter) provided you sell them with about a
week left in them if the underlying stock hasn't moved. On of
my favorites right now is the ATT April 20 call option. It's
quoted in the WSJ at 1/8 for closing, but frequently trades at
1/16 during the day. If you can manage to get it at 1/16 there
is a 75% probability that you would double your money - 2* commisions
within 24 hours. But you must deal in significant quantities or
the commissions are unreal.
Option strategies:
Purchase call options in stocks that you expect to go up.
Described adequately above.
.
--
Howard D. Trachtman SUNY/Buffalo
{hao, pur-ee, uwvax}!seismo!rochester!rocksvax!sunybcs!hdt (UUCP)
hdt.sunybcs@rand-relay (ARPA)
US Snail: 2080 Niagara Falls Blvd.
Tonawanda, NY 14150-5545 (use them all, if you dare)