BAC-WT - Bank of America Warrants

[ERICOPOLY]

I wish it could be shown that JP Morgan was encouraged by the feds to rescue Bear Stearns.

 

Then JP Morgan could countersue the government with misrepresentation claims of their own.

 

Wishful thinking, I know.  It's really stupid to think that by making JP Morgan pick up the tab this will serve as a warning to prevent it from happening again -- when JP Morgan isn't the one that committed the so-called fraud.

 

Like if the neighbor's dog is barking, you shoot the cat as a warning to other dogs.

[LC]

Maybe banks should sue consumers for taking out mortgages they couldn't afford or lying on their applications. 

 

This is on its face a faulty premise.  The average consumer is never wrong.  If the banks don't make a mortgage, the banks are wrong.  If the banks do make a mortgage, the banks are wrong.  I guess you haven't heard that the banks are greedy.  I liken it to fast food.  The greedy fast food establishments are forcing people to eat their tasty fare.  They have no choice but to gain weight.  It's a terrible thing.

 

I wouldn't go that far. The fault lies with each party's responsibility. If a bank gives me a mortgage and I default, am I at fault for the bank's lost profits? Of course not. They agreed to lend me the money. Likewise, are the banks at fault for giving me a mortgage I can't afford and repossessing my house? Of course not, I freely entered into the mortgage agreement in the first place.

 

I agree.  I think Kraven was just using a bit of sarcasm with all of the negative media around banks right now.  Like these lawsuits that investors who purchased MBS's and are now suing the banks because the loans turned sour...do your own diligence...you made the investment, now accept the risk.  Too much talk of fraudulent behavior by the banks...why don't investors sue these companies for making such poor choices in investments!  The only people getting rich at the end of the day aren't the banks...it's the lawyers!  Cheers!

 

The bolded is literally the most powerful incentive scheme in the modern era.

I'm inclined to agree with you, and frankly I find it utterly disgusting.

[Parsad]

 

 

Like if the neighbor's dog is barking, you shoot the cat as a warning to other dogs.

 

Actually, think about what that does to the dog then...maybe I'll bark some more and get rid of a few more cats!  The government does about as well as Wall Street in creating rational incentives for behavior and conduct.  Cheers!

[Uccmal]

Whatever became of caveat emptor? 

 

Like the analogy Eric. 

 

I think the markets are seeing this for what it is.... electioneering.  JPM was up almost a buck today and BAC was up 3% on the news of the potential fraud cases.  Politicians make Wall Street look downright pristine. 

 

As to the other BAc news, they are rapidly rolling debt, and pseudo debt, over to cheaper options. 

 

 

[Kraven]

Maybe banks should sue consumers for taking out mortgages they couldn't afford or lying on their applications. 

 

This is on its face a faulty premise.  The average consumer is never wrong.  If the banks don't make a mortgage, the banks are wrong.  If the banks do make a mortgage, the banks are wrong.  I guess you haven't heard that the banks are greedy.  I liken it to fast food.  The greedy fast food establishments are forcing people to eat their tasty fare.  They have no choice but to gain weight.  It's a terrible thing.

 

I wouldn't go that far. The fault lies with each party's responsibility. If a bank gives me a mortgage and I default, am I at fault for the bank's lost profits? Of course not. They agreed to lend me the money. Likewise, are the banks at fault for giving me a mortgage I can't afford and repossessing my house? Of course not, I freely entered into the mortgage agreement in the first place.

 

I agree.  I think Kraven was just using a bit of sarcasm with all of the negative media around banks right now.  Like these lawsuits that investors who purchased MBS's and are now suing the banks because the loans turned sour...do your own diligence...you made the investment, now accept the risk.  Too much talk of fraudulent behavior by the banks...why don't investors sue these companies for making such poor choices in investments!  The only people getting rich at the end of the day aren't the banks...it's the lawyers!  Cheers!

 

Yep, sarcasm.  In terms of the lawyer point, note that it is a handful of specific high end plaintiffs law firms that are getting rich.  It isn't the "normal" big corporate law firms.  Among the top securities litigators one of the problems with the big law firms was that typically the banks couldn't be sued because of conflict issues, both real (legal) and business (relationship).  So this work was always left for the ambulance chaser type firms with a few exceptions like Kasowitz, Quinn, etc.  In the wake of the financial crisis there were a number of very senior and well known securities litigators who said screw that, I'm going to get rich.  They left to start their own boutiques so they could immediately sue the banks.  Some of these shops quickly grew from a few people to dozens or more.  It's those people getting rich as they will take a piece of any settlement.  For the major big law firms it's kind of just business as usual and doesn't make up for all the corporate transactions lost over the past 5 years or so.

[Kraven]

I wish it could be shown that JP Morgan was encouraged by the feds to rescue Bear Stearns.

 

Then JP Morgan could countersue the government with misrepresentation claims of their own.

 

Wishful thinking, I know.  It's really stupid to think that by making JP Morgan pick up the tab this will serve as a warning to prevent it from happening again -- when JP Morgan isn't the one that committed the so-called fraud.

 

Like if the neighbor's dog is barking, you shoot the cat as a warning to other dogs.

 

I was always under the impression that JPM was encouraged to rescue Bear.  It is something they desperately wanted.  They felt at the time at least (not sure if their views have changed) that they were unable to directly provide funds to a financial that wasn't a commercial banking institution.  They got around that by sticking JPM in the middle.  I thought I recalled that Dimon initially said no and had to be brought around.  Of course, at the time at least it was thought that JPM got a great deal out of it.  I don't remember exact numbers but thought that what they paid for Bear was less than Bear's new midtown office building was worth.

[CONeal]

Maybe banks should sue consumers for taking out mortgages they couldn't afford or lying on their applications. 

 

This is on its face a faulty premise.  The average consumer is never wrong.  If the banks don't make a mortgage, the banks are wrong.  If the banks do make a mortgage, the banks are wrong.  I guess you haven't heard that the banks are greedy.  I liken it to fast food.  The greedy fast food establishments are forcing people to eat their tasty fare.  They have no choice but to gain weight.  It's a terrible thing.

 

I wouldn't go that far. The fault lies with each party's responsibility. If a bank gives me a mortgage and I default, am I at fault for the bank's lost profits? Of course not. They agreed to lend me the money. Likewise, are the banks at fault for giving me a mortgage I can't afford and repossessing my house? Of course not, I freely entered into the mortgage agreement in the first place.

 

I agree.  I think Kraven was just using a bit of sarcasm with all of the negative media around banks right now.  Like these lawsuits that investors who purchased MBS's and are now suing the banks because the loans turned sour...do your own diligence...you made the investment, now accept the risk.  Too much talk of fraudulent behavior by the banks...why don't investors sue these companies for making such poor choices in investments!  The only people getting rich at the end of the day aren't the banks...it's the lawyers!  Cheers!

 

The bolded is literally the most powerful incentive scheme in the modern era.

I'm inclined to agree with you, and frankly I find it utterly disgusting.

 

What would be classic is if one of these lawyers goes into a bank and get turned down due to the potential litigation risk.

[Uccmal]

I was thinking about the warrants in relation to the recent run-up in the AIG warrants.

 

I am guessing that the moment BM mentions the word dividend these things should pop, probably a fair bit, since the stock will pop as well.  And we are getting closer to that date, very quickly. 

 

I was looking at the start of this thread.  I initiated the warrant position at around 6.50 when the stock was 14 or so. 

 

Anyway, really just random thoughts.  This company is so different from two years ago when this thread started; the warrants are half the price, and then stock is 2/3.  Mr. Market delivers huge gifts, sometimes. 

 

 

[finetrader]

Al

don't you think it is just normal that the warrants has declined more on a % basis than the common since it is a leveraged instrument?

 

 

[claphands22]

Al

don't you think it is just normal that the warrants has declined more on a % basis than the common since it is a leveraged instrument?

 

Too often the warrant rises less than the stock (by %) and falls more (by %). Combination of lower implied volatility, less time value and my own memory biases I guess.

 

[alertmeipp]

Al

don't you think it is just normal that the warrants has declined more on a % basis than the common since it is a leveraged instrument?

 

Too often the warrant rises less than the stock (by %) and falls more (by %). Combination of lower implied volatility, less time value and my own memory biases I guess.

 

 

For long-dated option, + the general perception that the rise or fall is short-lived or ppl realize the strike price become less and less achievable within the time frame.

[ERICOPOLY]

Let's say that people get dismayed by the low long term rates (pinching net interest income)... this will lead to lower estimates of where the stock is at in 6 years.

 

Then at the same time people see the progress the company has made and gain more confidence that it will survive without dilution.  The common stock price gradually rises.

 

I suppose if both happen at the same time you can have a warrant price that tracks or lags the common for a period of time.

 

Or maybe I'm just trying to fit a narrative to random facts.

[Uccmal]

The warrant/common diveregence wasn't really what I was noting.  It was more that this thread is two years old, and the stock price is down to 2/3 of where it was with much less uncertainty, NOW.

 

Some of the items we noted at the beginning of this thread aren't even relevant now.

 

My other primary thought was that these warrants may take a big price jump, when the dividend increases get announced. 

 

I cant really comment on the warrant behaviour relative to the stock.  There is not really any formula, or precedent, for options with dating this far out. 

[meiroy]

 

How were the TARP warrants priced in the first place?

[berkshiremystery]

 

How were the TARP warrants priced in the first place?

 

Here you have the BAC warrant price at auction date.

 

http://seekingalpha.com/article/637321-tarp-warrants-revisited-part-2-opportunities-exist-for-long-term-investors

 

http://static.cdn-seekingalpha.com/uploads/2012/6/3/356105-13386986670200977-Randall-Hsu_origin.png

 

 

 

[meiroy]

 

How were the TARP warrants priced in the first place?

 

Here you have the BAC warrant price at auction date.

 

http://seekingalpha.com/article/637321-tarp-warrants-revisited-part-2-opportunities-exist-for-long-term-investors

 

http://static.cdn-seekingalpha.com/uploads/2012/6/3/356105-13386986670200977-Randall-Hsu_origin.png

 

I mean, how were the initial prices for the TARP warrants decided on by the sellers? It would be interesting to know how they calculated it and their reasoning.

 

[racemize]

So I've been recently trying to understand how warrants will work once we get closer to expiry, and presumably once they get to be "in the money".  In particular, I was wondering how the leverage gotten by the warrants will manifest as the common price appreciates (e.g., if most of the leverage will be obtained once the warrants are "in the money" or close to current break-over prices).  The below is my current line of thinking, but I'd love to hear any input from others who have also thought this through and/or have more experience with valuing options (these warrants are actually my first foray into options).

 

First, here's some simplified assumptions to make things easier to do in my head: current common price is $20 and warrant strike price is $13.

 

At this point, the warrant price essentially has a floor at $7 since an arbitrager could come in at any significant deviation below $7.

 

Accordingly, the price should be at least $7, but perhaps it could go higher.  If it were lockstep with (common-strike price), then there would no longer be any benefit for warrant holders.  However, a new buyer choosing between warrants and common, at this point, may choose warrants over common to get more leverage, depending on assumed growth rates.  Thus, if there were no growth, the two choices would be the same.  On the other hand, any assumption of positive growth would immediately be in favor of warrants, since you can get more of them.  Thus, the reasoning should be based on the "break over" point (the point at which the warrants and the common would have even gains) at the time of purchase.  The more growth assumed, the higher the price one is willing to pay for warrants. 

 

All this to say, it seems quite likely that the warrants prices will be greater than (common-strike price), leading to the question of when to sell them and recognize all the leverage we have had up to this point.  Based on the above thinking, my planned course of action is to sell the warrants once their current break-over point with the common exceeds my projections, including a margin of safety. 

 

Would appreciate any thoughts on the above!

 

 

[woltac]

So I've been recently trying to understand how warrants will work once we get closer to expiry, and presumably once they get to be "in the money".  In particular, I was wondering how the leverage gotten by the warrants will manifest as the common price appreciates (e.g., if most of the leverage will be obtained once the warrants are "in the money" or close to current break-over prices).  The below is my current line of thinking, but I'd love to hear any input from others who have also thought this through and/or have more experience with valuing options (these warrants are actually my first foray into options).

 

First, here's some simplified assumptions to make things easier to do in my head: current common price is $20 and warrant strike price is $13.

 

At this point, the warrant price essentially has a floor at $7 since an arbitrager could come in at any significant deviation below $7.

 

Accordingly, the price should be at least $7, but perhaps it could go higher.  If it were lockstep with (common-strike price), then there would no longer be any benefit for warrant holders.  However, a new buyer choosing between warrants and common, at this point, may choose warrants over common to get more leverage, depending on assumed growth rates.  Thus, if there were no growth, the two choices would be the same.  On the other hand, any assumption of positive growth would immediately be in favor of warrants, since you can get more of them.  Thus, the reasoning should be based on the "break over" point (the point at which the warrants and the common would have even gains) at the time of purchase.  The more growth assumed, the higher the price one is willing to pay for warrants. 

 

All this to say, it seems quite likely that the warrants prices will be greater than (common-strike price), leading to the question of when to sell them and recognize all the leverage we have had up to this point.  Based on the above thinking, my planned course of action is to sell the warrants once their current break-over point with the common exceeds my projections, including a margin of safety. 

 

Would appreciate any thoughts on the above!

 

Would the attributes you ascribe to the warrants exist when the stock is at $20 at any point prior to expiration?  I am not sure how it would differ as expiration approached.

 

Since I have not bought all the BAC I wanted at this point, your post made me think about the relative merits of buying the warrants or the stock today with the warrants at $3.66 and the stock at $9.30. 

 

          WTA                 BAC

    Gain/(Loss)  % Gain/(Loss) %

Price     3.66             9.30

 

13.00    (3.66) -100% 3.70  40%

16.00    (0.66) -18%   6.70  72%

19.00    2.34   64%   9.70  104%

22.00    5.34 146%    12.70  137%

 

So, in order to buy the warrants over the stock I would need to expect that the stock would be at least $21 a share at some point?  Other than a loss on my investment under $16.66, what other factors should be considered?

 

 

[racemize]

Would the attributes you ascribe to the warrants exist when the stock is at $20 at any point prior to expiration?  I am not sure how it would differ as expiration approached.

 

Since I have not bought all the BAC I wanted at this point, your post made me think about the relative merits of buying the warrants or the stock today with the warrants at $3.66 and the stock at $9.30. 

 

    WTA     BAC

Gain/(Loss) % Gain/(Loss) %

Price     3.66     9.30

 

13.00  (3.66) -100% 3.70 40%

16.00 (0.66) -18% 6.70 72%

19.00 2.34 64% 9.70 104%

22.00 5.34 146% 12.70 137%

 

Assuming I undertand you correctly, my assumption above is that expiry is still far enough away for growth to occur.  As it gets to expiry, the value will pretty much have to be (common-strike price-arbitrage fee), it seems to me.

 

With respect to your chart, I'm not sure how your calculating it--I guess you are assuming warrant price is common-strike at each point?  (Also, note that strike is actually 13.30, I just rounded above for easier math).  The numbers seem a bit off to me.  In any event, the returns should be higher for warrants based on the fact that you can buy more of them at the initial time than common, not on a 1:1 comparison of a single warrant to a single common share (the common share always wins on a 1:1 comparison due to the strike price cost).  I have break over at 21.94 (no dividends) and 22.19, if you include the dividends under the threshold.  I've set up a spreadsheet to calculate it for me based on live numbers (e.g., for AIG, BAC, WFC, JPM).

[racemize]

Ok, I see how your chart works now I think.  You're just doing it a different way than mine, but I think the result is the same.

[woltac]

Ok, I see how your chart works now I think.  You're just doing it a different way than mine, but I think the result is the same.

 

I adjusted for the proper strike price of $13.30, input $21.94 into the price and verified your break even point.  I also added additional higher prices into the attached spreadsheet. 

 

So I am assuming that given the same dollar amount invested, the warrants only have an advantage when the market price is above $21.94 (hence the term "break even").  I think I am starting to understand this.  Thank you for being patient.   

BACWTA_vs_BAC_on_August_8_2012.xlsx

[racemize]

Ok, I see how your chart works now I think.  You're just doing it a different way than mine, but I think the result is the same.

 

I adjusted for the proper strike price of $13.30, input $21.94 into the price and verified your break even point.  I also added additional higher prices into the attached spreadsheet. 

 

So I am assuming that given the same dollar amount invested, the warrants only have an advantage when the market price is above $21.94 (hence the term "break even").  I think I am starting to understand this.  Thank you for being patient. 

 

Yeah, the only caveat being that you won't get the 4 cents per share per year with the warrant.  For the dividend amount over that, you'll get a strike price adjustment, discussed earlier in the thread.  (Also, it may be worth noting Eric's comments re the ability to compound the dividends on the common).  That 4cents per share increases the break even just a bit.

[Sunrider]

Gentlemen - the one other thing to note here is that you need to put less money up front with the warrants ... (of course, arguably, there's a point of return on BAC by expiration below which that won't matter much).

 

C.

[racemize]

Gentlemen - the one other thing to note here is that you need to put less money up front with the warrants ... (of course, arguably, there's a point of return on BAC by expiration below which that won't matter much).

 

C.

 

The less money up front is what allows you to have higher gearing and thus get higher results.  In other words, that should be reflected in the % gains in either of our charts, I believe.

[MYDemaray]

Are you using a warrant valuation model to arrive at your warrant prices in relation to the underlying?  Didn't look like you were. Obviously time value and implied volatility will have a large effect on warrant pricing.  In addition, remember that at-the-money warrants tend to have a delta of 0.50 (they move 50 cents for each dollar move in the underlying).  As they go in the money, delta will move towards 1.0 -- a deep in the money option will move dollar for dollar with the underlying). Here is a spreadsheet from Aswath Damodoran for valuing warrants: http://goo.gl/kbFBj