There is a great episode of The Art of Charm podcast, formerly hosted by Jordan Harbinger, whose new show I highly recommend.

It’s really just one comment in the show, but it struck me at the time as profound. Jordan was speaking about the news (media) and how they over exaggerate everything in order to sell copy. In order to put things in perspective, he uses a simple framework.

Think of a news story on something that you actually know something about, or are even an expert in, and what your reaction to that story was. Most likely you were thinking, “That’s not right.” “That’s true, but that isn’t really what that means.” “That is totally wrong.” Or something along those lines.

It’s very likely you came away from the story either flat out disagreeing with the conclusion or implication of the story. Or, at best, you just disregarded it as something irrelevant because many of the facts, assumptions, or conclusions were wrong.

Jordan’s point was the news, if you have to watch it for some reason, is not really as scary as the media makes it seem. They need to sell copy, and as the old story goes, you don’t pick up a newspaper at the newsstand (do they still have those?) predicting sunny skies.

But you do pick up, and pay for, one that is predicting “violent weather”, and my favorite from TV weather these days, “millions at risk.” They’re usually talking about “millions at risk” of getting rained on that day. Didn’t know that was a “risk”, but again, gotta sell. There’s your free marketing lesson for the day.

I often think of Jordan’s framework when I’m scanning through a stock message board, or Facebook group aimed at stock picking. Most of the advice posted in such places is useless at best, and in some cases it’s just wrong and can hurt your returns if you heed it.

What is a warrant redemption clause

It’s in these message boards that I often see a post similar to this:

Followed closely by this:

While those posts concern Phunware (PHUN) and its warrants (PHUNW), a warrant redemption clause is a standard clause that many companies that issue warrants include in their regulatory filings.

Let’s break this down into easy to understand, plain language.

Let’s pretend I still have my first car, a ’77 Thunderbird (beast of a car, I loved that car). It’s now a collector’s item (probably not, but to me it is), and you really want to buy it from me. I say it’s $40,000 and you say I don’t have that now, but might in 6 months.

OK, I’m an amiable guy, let’s write down on a piece of paper that you can buy the car from me anytime in the next 6 months for $40,000. BUT, we’ll also put in our little contract that if I get another offer I can call you (get it, play on words, “call redemption” / “call you”) and say you have one week to buy it at $40,000 or our contract is void.

So, if I call you and tell you I have that offer, you have one week to still buy the car at $40,000, and then after that week the contract is worth nothing. This is EXACTLY like a call redemption. You still have the one week in which to exercise your right to buy the car for $40,000. If you have someone lined up to buy the car from you for $50,000, you could do one of two things.

1. Buy the car from me for $40,000, or EXERCISE your rights under the contract, buy the car and turn around and sell it for $50,000. $10,000 profit in your pocket. (Just like exercising your warrants and selling the stock you get.)
2. Or, you could assign your rights under the contract (AHHHH, legalese!!)… Scratch that. You can tell your friend who wants to buy the car you’ll sell him the contract for $10,000. He gives me $40,000 for the car, and you $10,000, so he still pays $50,000 and you still make $10,000. (Just like selling your warrants.)

That’s it. That’s all a redemption is. You can still exercise the warrants, you just have to do it by a certain time, or they DO become worthless (or worth a penny in most cases.)

The Value of Leverage

Let me make a quick follow-up point on number 2. We’re getting deep in the tall grass here, but stick with me for one second. This is how you should be thinking about these types of situations, not just with warrants, but with any other type of arbitrage, be it in the market, in your work or negotiating with your kids (then you can tell them what you’ve done and teach them a little business strategy).

Everything that can be bought and sold has some value. It may not be clear what the value is, especially if there is no market for the “thing”, but most things have some value to somebody. I recently heard of a woman that takes moose poop and puts it on clocks where the numbers would be. When you look at the clock you can say “it’s 3 turdy”. I’m not kidding, she apparently does quite well in her business, Google it.

A warrant, and an option as well, give you leverage. And by leverage I mean you can control more of one thing using less of another. So we have “value” and “leverage”.

Since a warrant gives you leverage, or the ability to control something bigger (more stock), it is more valuable than the equivalent amount of stock. This is why a warrant, and an option, trades at a premium. (I know, I know, all the Greeks, and Black-Scholes, and any financial modeling software you can think of attempt to tell you the “value” of an option or warrant. But models are only as good as the data and assumptions that are put into them. That data can be wrong, and there is a higher likelihood of it being wrong when that data is limited.)

It has been my experience that warrants, and I have often found a parallel to other things in business and life, that appear to have a certain value (as in the market price they are trading at), but that give you leverage, are more valuable than you might believe. Now let’s take a quick look back at number 2 in our example.

Because you had the the contract, that let you buy the car for $40,000, you were able to make $10,000 without putting down a dime. (Even if I charged you $1,000 to write the contract, equivalent to the price of a warrant or option, you still made a huge return by putting down very little money.)

The cool thing about warrants, that aren’t being redeemed, is that if you use them correctly, you can use their value again and again to increase your wealth. You can do this using arbitrage, or selling common stock, or even options, against your warrants, and then buying it back at favorable prices. Or, in the case of options, letting them expire. So, to someone who is knowledgeable about warrants, they are often more valuable than they may appear to others.

If I’ve lost you completely in the last few paragraphs, no worries. Here are some rules of thumb derived from what I’m attempting to explain:

1. Never exercise warrants unless you have to. Obviously if they are expiring or being called, etc. there may be occasion to exercise them. But in general, you want to either sell the warrants or short common against them, or cover common already shorted and then reshort, etc. etc. Exercising warrants ties up capital which you normally don’t have to do, or you may not have. The only time I’ve exercised large numbers of warrants is when I’ve put on large hedged position for a discount, short common and long warrants, and the warrants are expiring.
2. Hold onto your warrants and trade against them. As I just explained, warrants give you the opportunity to make money in a number of ways, so if you have the capital available, hold your warrants and trade against them. You can make a LOT of money if you have a warrant that is going out of the money because a stock, which you’re short, is falling. After you’ve covered your short in the stock, and your warrants are worth next to nothing, hold onto them. They can be a long term option on more profits if the stock comes back.

Bottom line, things that give you leverage are often more valuable than you realize. Hold on to that value.

Why Do Companies Call Warrants

Warrants, while they can be issued for many reasons, are probably most often issued as sweeteners for investors to give a company more money when it goes public or issues additional stock. There are basically two ways to do this.

1. Issue the warrant separately. As an investor I may not want to pay $40 for a share of stock in an IPO, but I may be willing to pay $5 for a chance to buy the stock at $35 for the next 3 years. In this way a company gets cash from the buyers at $40 as well as value investors who might otherwise not have invested.
2. Bundle the warrant with the common stock to make the common stock appear more attractive. SPACs do this as standard practice. They will issue a “unit” which contains a share of common stock, a warrant, or half a warrant to buy common stock, once a deal is completed, and often a right. For $10, the IPO price, you get all three. It’s like getting a discount on your phone bill, cable, and internet service bundle…sweet.

You might be asking, if they gave the warrants as a sweetener to get more investors to invest, then why would they have a redemption clause, and why call the warrants above a certain price?

And to that I say, mo’ money, mo’ money, mo’ money!

When a company redeems warrants they aren’t “trapping” their warrant investors. If they are calling their warrants, at that point in the game, everyone, the warrant holders, the stockholders, and the company, are all happy campers. Per the redemption clause, the warrants are called only when the stock has gone UP and traded up for several days…standard 20 out of 30, but can be different.

Everyone has made money. But now, the company, which enabled the investor to make money by doing what it should and having its stock price rise, would like some payback. So, they make you redeem (or sell, its OK to sell them, remember this is one of the times you can, when they are going away) the warrants, and they get the exercise value.

Unlike an option, when you exercise a warrant, the money (eg, exercise terms, one warrant plus $10 gets you one share of common…the $10 goes to the company) from the expiration is given to the company. And, in return they give you stock that they have registered for the purpose of giving to warrant holders who exercise their warrants.

In a (really big) nutshell, that’s it. Now you know what a stock warrant redemption clause is (fairly standard, not a trap, the warrant only goes to $.01 and is not exercisable if you don’t exercise in the given time), why companies issue warrants (as a sweetener, to get more money), and why companies call warrants for redemption when they trade over a certain price for a certain amount of time (mo’ money for the company, everyone is happy).

If you want to make mo’ money with warrants yourself, check out my warrant course here. If you can’t make more than the cost of the course in just one warrant we’ve got other issues.