BAC-WT - Bank of America Warrants

[Cardboard]

Racemize,

 

AIG will pay a dividend for sure in the future per Benmosche and they should have more flexibility than BAC being a SIFI. Relative to their current earnings, $0.68 a year is easily achievable and based on his comments, he wants an attractive dividend for investors. $1.50 or $2 a year is not at all out of the question.

 

It is true that the threshold on AIG or a yield of 1.7% at current price vs BAC currently at 0.3% is much higher for adjustments. It just seems to me that the BAC warrants reflect already the dividend increases while AIG reflects none. So I was just wondering about the optimism present in the "A" warrants or "it is a sure thing" about the dividend increases vs AIG. Was also wondering if I am not missing some other big factor.

 

Cardboard

[MYDemaray]

If you guys really wanted to geek out, you could model the warrants using a normal distribution of dividend and price expectations.  Here are some nice tools:

 

RiskAmp (MonteCarlo excel plugin): http://www.thumbstacks.com/

 

Hoadley warrant valuation plugin: http://www.hoadley.net/options/develtoolsaddin.htm

 

Personally, I think it's overkill, but if you're bored....

 

[StubbleJumper]

The AIG warrants are 8% annualized cost of non-recourse leverage (a bit higher if dividends are paid given that you miss out on part of the dividend with the AIG warrants)

 

The "put" is also more valuable in the AIG warrants because it's for 8 years, not 6 years as with the BAC warrants.

 

 

But it's not just theta, it's also sigma is relevant.  As we have discussed at length on this thread, BAC has faced a great deal of litigation over recent years, and still faces a number of suits.  Reasonable people can reasonably disagree about the outcome of those suits (and future suits that we might imagine).  A potential outcome of this litigation is a permanent impairment of BAC's equity.  Obviously we who hold the stock believe this to be a remote outcome, but it's still a possibility which contributes to the value of a long-term put.  Similarly, there is a view (legitimate or otherwise) that the future may not be rosy for the banking industry if QE is wound-down...which again contributes to the value of a put.

 

We can clearly see the potential for multiple bags in BAC.  We have dissected the risks and concluded that a downside is improbable.  But in our enthusiasm for the multiple bags, we shouldn't forget that there could legitimately be a downside!

[ECCO]

There seems to be some pressure on the A warrant this morning. While the stock is up 10c, the warrants are down 5c, it seems many of you are trying to get out at 5.50$/warrants A. Good luck to those that are leaving the boat. That take balls and conviction to do that move before thurdays night result. 

[racemize]

Racemize,

 

AIG will pay a dividend for sure in the future per Benmosche and they should have more flexibility than BAC being a SIFI. Relative to their current earnings, $0.68 a year is easily achievable and based on his comments, he wants an attractive dividend for investors. $1.50 or $2 a year is not at all out of the question.

 

It is true that the threshold on AIG or a yield of 1.7% at current price vs BAC currently at 0.3% is much higher for adjustments. It just seems to me that the BAC warrants reflect already the dividend increases while AIG reflects none. So I was just wondering about the optimism present in the "A" warrants or "it is a sure thing" about the dividend increases vs AIG. Was also wondering if I am not missing some other big factor.

 

Cardboard

 

I agree with what you are saying--I think the difference in prices is the certainty + the loss dividends, although as you say, the market is probably giving them no credit versus uncertain credit.  I guess I don't find it clear how soon AIG's dividend will come and whether it will be a token dividend initially (e.g., less than 0.17), or a meaningful starting dividend. 

 

I also think that many people lump all the TARP warrants together, and ignore that AIG's has an extra 2 years on it. 

[ERICOPOLY]

The AIG warrants are 8% annualized cost of non-recourse leverage (a bit higher if dividends are paid given that you miss out on part of the dividend with the AIG warrants)

 

The "put" is also more valuable in the AIG warrants because it's for 8 years, not 6 years as with the BAC warrants.

 

 

But it's not just theta, it's also sigma is relevant.  As we have discussed at length on this thread, BAC has faced a great deal of litigation over recent years, and still faces a number of suits.  Reasonable people can reasonably disagree about the outcome of those suits (and future suits that we might imagine).  A potential outcome of this litigation is a permanent impairment of BAC's equity.  Obviously we who hold the stock believe this to be a remote outcome, but it's still a possibility which contributes to the value of a long-term put.  Similarly, there is a view (legitimate or otherwise) that the future may not be rosy for the banking industry if QE is wound-down...which again contributes to the value of a put.

 

We can clearly see the potential for multiple bags in BAC.  We have dissected the risks and concluded that a downside is improbable.  But in our enthusiasm for the multiple bags, we shouldn't forget that there could legitimately be a downside!

 

 

Correct, let's not pay for all six years upfront smugly believing nothing will go wrong.

 

Ironically though, you seem to be defending the idea of buying the warrants.

 

Let's pay for two years upfront (with the 2015 $12 strike calls) and wait and see.  Should things be going well, we'll take delivery of the shares and protect the loan with a new purchase of puts.

 

 

[StubbleJumper]

The AIG warrants are 8% annualized cost of non-recourse leverage (a bit higher if dividends are paid given that you miss out on part of the dividend with the AIG warrants)

 

The "put" is also more valuable in the AIG warrants because it's for 8 years, not 6 years as with the BAC warrants.

 

 

But it's not just theta, it's also sigma is relevant.  As we have discussed at length on this thread, BAC has faced a great deal of litigation over recent years, and still faces a number of suits.  Reasonable people can reasonably disagree about the outcome of those suits (and future suits that we might imagine).  A potential outcome of this litigation is a permanent impairment of BAC's equity.  Obviously we who hold the stock believe this to be a remote outcome, but it's still a possibility which contributes to the value of a long-term put.  Similarly, there is a view (legitimate or otherwise) that the future may not be rosy for the banking industry if QE is wound-down...which again contributes to the value of a put.

 

We can clearly see the potential for multiple bags in BAC.  We have dissected the risks and concluded that a downside is improbable.  But in our enthusiasm for the multiple bags, we shouldn't forget that there could legitimately be a downside!

 

 

Correct, let's not pay for all six years upfront smugly believing nothing will go wrong.

 

Ironically though, you seem to be defending the idea of buying the warrants.

 

Let's pay for two years upfront (with the 2015 $12 strike calls) and wait and see.  Should things be going well, we'll take delivery of the shares and protect the loan with a new purchase of puts.

 

 

Nope, not defending the idea of buying anything; I think there's still good money to be made on pretty much any long BAC position.  I'm simply offering an explanation about why the warrants seemingly have very expensive carry....which is that it's not all carry!    ;) 

 

 

SJ

[fareastwarriors]

http://www.bloomberg.com/news/2013-03-13/bofa-said-to-cut-5-of-property-appraisers-amid-slowdown.html

 

 

BofA Said to Cut 5% of Property Appraisers Amid Slowdown

 

[Mephistopheles]

Correct, let's not pay for all six years upfront smugly believing nothing will go wrong.

 

Ironically though, you seem to be defending the idea of buying the warrants.

 

Let's pay for two years upfront (with the 2015 $12 strike calls) and wait and see.  Should things be going well, we'll take delivery of the shares and protect the loan with a new purchase of puts.

 

 

 

Are the calls you own hedged? What about the risk that BAC may trade below $12 and you lose the whole investment? Are you saying that you are only putting up $2 instead of $12, so the risk of losing the $2 is ok?

[nkp007]

I've read the past few pages and I couldn't help but feel that perhaps we are overthinking this.

[ERICOPOLY]

Correct, let's not pay for all six years upfront smugly believing nothing will go wrong.

 

Ironically though, you seem to be defending the idea of buying the warrants.

 

Let's pay for two years upfront (with the 2015 $12 strike calls) and wait and see.  Should things be going well, we'll take delivery of the shares and protect the loan with a new purchase of puts.

 

 

 

 

Are the calls you own hedged? What about the risk that BAC may trade below $12 and you lose the whole investment? Are you saying that you are only putting up $2 instead of $12, so the risk of losing the $2 is ok?

 

The calls have the embedded put that StubbleJumper has been talking about.  That is the hedge.

 

But I prefer to think of this in terms of what it costs, annualized, for the non-recourse leverage.  I think like a businessman in this regard, not in terms of casino language.  What will it cost me if I hold these calls to duration?  It will cost me 10% annualized for the non-recourse leverage.

 

The word "non-recourse" implies the put.  Which is why it's not necessary to tell me about the put.

 

 

[racemize]

So, the implied put seems a bit confusing to me, as I never hold that portion of the cash.  I typically think of it in terms of, "I'm going to allocate x to this, how should I allocate it?".  Choices being stock, warrants, options, whatever.  In that sense, I don't have any left over cash, e.g., if I have 12 dollars and decide to put it in A warrants, I just buy two As and don't have any left-over cash, and presumably, that put.  Am I thinking about this wrong (probably)?

[StubbleJumper]

Correct, let's not pay for all six years upfront smugly believing nothing will go wrong.

 

Ironically though, you seem to be defending the idea of buying the warrants.

 

Let's pay for two years upfront (with the 2015 $12 strike calls) and wait and see.  Should things be going well, we'll take delivery of the shares and protect the loan with a new purchase of puts.

 

 

 

 

Are the calls you own hedged? What about the risk that BAC may trade below $12 and you lose the whole investment? Are you saying that you are only putting up $2 instead of $12, so the risk of losing the $2 is ok?

 

The calls have the embedded put that StubbleJumper has been talking about.  That is the hedge.

 

But I prefer to think of this in terms of what it costs, annualized, for the non-recourse leverage.  I think like a businessman in this regard, not in terms of casino language.  What will it cost me if I hold these calls to duration?  It will cost me 10% annualized for the non-recourse leverage.

 

The word "non-recourse" implies the put.  Which is why it's not necessary to tell me about the put.

 

 

The only reason to speak of the put is that the 13% cost of leverage that you calculated sounds expensive.  But expensive compared to what?  It's hard to find non-recourse leverage in other fields of life to reasonably compare it to (ie, you can't compare it to a mortgage rate, or a margin account rate....would a credit card be the best comparison?).  We naturally say, wow, a 13% interest rate is ridiculous in a near-zero rate environment, but that's because few of us ever borrow on a risky, non-recourse basis.

 

So what else can you compare it to?  Well, you've correctly gone through the process of comparing LEAPS to the warrants to quantify the comparative cost of those two sources of non-recourse debt.  And you are absolutely right, that's probably the best reference point.  The only issue is that the term is much different because the leaps are 2 years and the WTs are 6 years, so it's not a surprise that the cost is higher for the warrants. 

 

I don't think anyone has any disagreement about any of this.  I think you are clear about what you are buying when you speak of non-recourse leverage.  But, not all readers will understand it the same way.  IMO, it's important to explicitly state that you can't compare the 13% cost to a margin account interest rate, and that 6-year non-recourse leverage should cost much more than 2-year non-recourse leverage. 

 

None of this means that you are incorrect in your assessment that the six-year warrants are mispriced relative to the LEAPs or common.  It just means a comparison to a risk-free or low-risk rate would be a big mistake!

 

Cheers,

 

SJ

 

 

 

[StubbleJumper]

So, the implied put seems a bit confusing to me, as I never hold that portion of the cash.  I typically think of it in terms of, "I'm going to allocate x to this, how should I allocate it?".  Choices being stock, warrants, options, whatever.  In that sense, I don't have any left over cash, e.g., if I have 12 dollars and decide to put it in A warrants, I just buy two As and don't have any left-over cash, and presumably, that put.  Am I thinking about this wrong (probably)?

 

 

Think about it from a basic put-call parity perspective:

 

Stock + Put = Bond + Call

 

 

In earlier posts, Eric went through the process of observing that the Bond + Call looked to be much more expensive than the Stock (ie, you'd need a 13% return on your bond).  This is the reason why I reminded people not to forget that you get a valuable Put along with the stock!

 

In your case, you are not holding cash, so you are buying:

 

Call = Stock + Put - Bond

 

which you can intuitively understand in that you are leveraging.

 

 

SJ

 

 

[racemize]

thank you very much for your explanation.

[ERICOPOLY]

Correct, let's not pay for all six years upfront smugly believing nothing will go wrong.

 

Ironically though, you seem to be defending the idea of buying the warrants.

 

Let's pay for two years upfront (with the 2015 $12 strike calls) and wait and see.  Should things be going well, we'll take delivery of the shares and protect the loan with a new purchase of puts.

 

 

 

 

Are the calls you own hedged? What about the risk that BAC may trade below $12 and you lose the whole investment? Are you saying that you are only putting up $2 instead of $12, so the risk of losing the $2 is ok?

 

The calls have the embedded put that StubbleJumper has been talking about.  That is the hedge.

 

But I prefer to think of this in terms of what it costs, annualized, for the non-recourse leverage.  I think like a businessman in this regard, not in terms of casino language.  What will it cost me if I hold these calls to duration?  It will cost me 10% annualized for the non-recourse leverage.

 

The word "non-recourse" implies the put.  Which is why it's not necessary to tell me about the put.

 

 

The only reason to speak of the put is that the 13% cost of leverage that you calculated sounds expensive.  But expensive compared to what?  It's hard to find non-recourse leverage in other fields of life to reasonably compare it to (ie, you can't compare it to a mortgage rate, or a margin account rate....would a credit card be the best comparison?).  We naturally say, wow, a 13% interest rate is ridiculous in a near-zero rate environment, but that's because few of us ever borrow on a risky, non-recourse basis.

 

So what else can you compare it to?  Well, you've correctly gone through the process of comparing LEAPS to the warrants to quantify the comparative cost of those two sources of non-recourse debt.  And you are absolutely right, that's probably the best reference point.  The only issue is that the term is much different because the leaps are 2 years and the WTs are 6 years, so it's not a surprise that the cost is higher for the warrants. 

 

I don't think anyone has any disagreement about any of this.  I think you are clear about what you are buying when you speak of non-recourse leverage.  But, not all readers will understand it the same way.  IMO, it's important to explicitly state that you can't compare the 13% cost to a margin account interest rate, and that 6-year non-recourse leverage should cost much more than 2-year non-recourse leverage. 

 

None of this means that you are incorrect in your assessment that the six-year warrants are mispriced relative to the LEAPs or common.  It just means a comparison to a risk-free or low-risk rate would be a big mistake!

 

Cheers,

 

SJ

 

SJ,

Compare the 13% to the 8% cost (9.5% if dividend restored) cost of the leverage in the AIG warrants.

 

It's not like we don't have anything to compare it to. And those AIG warrants have 33% more life in them -- so if you think the leverage should be more expensive when of longer duration , then this is truly Alice In Wonderland.

 

We could alternatively compare it to the cost of the BAC calls, as I am doing.

[StubbleJumper]

SJ,

Compare the 13% to the 8% cost (9.5% if dividend restored) cost of the leverage in the AIG warrants.

 

It's not like we don't have anything to compare it to. And those AIG warrants have 33% more life in them -- so if you think the leverage should be more expensive when of longer duration , then this is truly Alice In Wonderland.

 

Is the risk (real or perceived) for BAC and AIG the same?  That's always the challenge of making cross-company comparisons.  Most of us on this board have a greater degree of comfort with BAC than does the broad investing public.  But, in all fairness, one unfavourable legal decision (or a series of unfavourable legal decisions) could legitimately impair BAC....as could further narrowing of the rate spread.  Those types of events give value to the embedded BAC put.  Is there an analogous potential impairment present in AIG?  Maybe on the life side...

 

We could alternatively compare it to the cost of the BAC calls, as I am doing.

 

Yes, this is probably the best approach and you've got the result that should be expected (ie, longer term options are more costly than the leaps). 

[jay21]

 

SJ,

Compare the 13% to the 8% cost (9.5% if dividend restored) cost of the leverage in the AIG warrants.

 

It's not like we don't have anything to compare it to. And those AIG warrants have 33% more life in them -- so if you think the leverage should be more expensive when of longer duration , then this is truly Alice In Wonderland.

 

We could alternatively compare it to the cost of the BAC calls, as I am doing.

 

Hi Eric, do you know what difference is in the implied vol between the BAC options you are looking at and the AIG close equivalent?

[StubbleJumper]

Eric,

 

Having given this a shade more thought, let's impute the cost of a 6-year european put option on BAC with a $13.3 strike:

 

Recall that put-call parity requires that:

 

Stock + Put = Call + Bond

 

 

Grabbing rough numbers from yesterday and using the warrant's $13.3 strike and a 3% risk free rate, this would look something like:

 

$12 + Put = $5.65 + $13.30/(1+3%)**6

 

Rearranging, this would value the 6-year BAC european put at:

 

Put = ~$4.78

 

 

So, does this make any sense?  Well, an American January 2014 put with a $12 strike is currently bid at $1.27.  An American January 2015 put with a $12 strike is bid at $2.08.  Obviously a $13.3 strike on a 6 year put is worth much more a $12 strike on a 2 year put...  So maybe the embedded put is appropriately priced, but it's simply inconsistent with your subjective probability that it will ever be in the money?

 

Interesting...

 

 

SJ

[ERICOPOLY]

Eric,

 

Having given this a shade more thought, let's impute the cost of a 6-year european put option on BAC with a $13.3 strike:

 

Recall that put-call parity requires that:

 

Stock + Put = Call + Bond

 

 

Grabbing rough numbers from yesterday and using the warrant's $13.3 strike and a 3% risk free rate, this would look something like:

 

$12 + Put = $5.65 + $13.30/(1+3%)**6

 

Rearranging, this would value the 6-year BAC european put at:

 

Put = ~$4.78

 

 

So, does this make any sense?  Well, an American January 2014 put with a $12 strike is currently bid at $1.27.  An American January 2015 put with a $12 strike is bid at $2.08.  Obviously a $13.3 strike on a 6 year put is worth much more a $12 strike on a 2 year put...  So maybe the embedded put is appropriately priced, but it's simply inconsistent with your subjective probability that it will ever be in the money?

 

Interesting...

 

 

SJ

 

I can't lose my $10 in cash if I go the route of the calls, the guy with the warrant is only protecting $6.65.

 

Now what was that you are telling me about my subjective opinion?

[StubbleJumper]

I can't lose my $10 in cash if I go the route of the calls, the guy with the warrant is only protecting $6.65.

 

Now what was that you are telling me about my subjective opinion?

 

 

It seems like you've got everything figured out.

 

Cheers.

 

SJ

[Olmsted]

I may be looking at this the wrong way - but I am getting a 2-year option leverage cost that is a bit above the warrants. 

 

25 is the warrant-common break-even - ignoring the dividend readjustment but also ignoring dividends on the common - which is probably the right way to look at it (the readjustments should cancel each other out).  That implies an annualized cost of leverage of about 13%.

 

The two-year option at $2.10, ignoring dividends, gives you a 10% cost of leverage.  But the two-year options don't benefit from the dividend adjustment.  So the leverage cost of the options is 10% plus lost dividends over the next two years.

 

If you wanted to make an apples-apples comparison, one could use the post-adjustment strike and shares/warrant and compare that to the options.  Guessing at an $11 strike and 1.2 shares/warrant I get a break-even at $19 versus the common stock - implying a leverage cost of 8% plus lost dividends over the next 6 years (stock price at 12.06, warrant price at 5.54 as write).

 

Now of course we don't expect the bulk of the capital return in the next two years - so the 2015 options look ok in that regard.  But unless I am way off, the warrants look a little cheaper than the options.

 

EDIT: since you're paying for dividend protection up front, options could be cheaper over the next two years since serious dividends won't kick in until later.

 

Is this totally wrong?

[Investmentacct]

mvp, the leverage from the warrants is more expensive than the leverage in the options. from my understanding, eric hasn't changed anything in his taxable accounts for the warrants.

 

However I am strongly considering it (I have decided to sell it, but the market isn't open and I still might waver).

 

I just mentioned how a 13% cost of leverage could change to a 10% cost of leverage as the stock nears $20.  That could eat up 20% of the current value of the warrant.

 

Right now my warrants in my taxable account carry a cost basis of $3.40.  $2.25 is the size of the capital gain.  The short term tax rate might be 20% higher, but that only kills off 50 cents of value, or roughly 9% of the present value of the warrant.

 

So holding for long-term capital gains rate might mean losing 20% in an effort to not lose 9% to the higher tax rate.

 

So it's a coin toss.  The 20% is going to be lost, IMO, when the stock gets near $20.  So perhaps I may as well just eat the 9% value come tax time next year and sell the warrants tomorrow.

 

EDIT:  Actually, forget what I said above.  If I pay a 40% tax rate on $2.25 of short-term capital gain, that's only 90 cents of tax owed.  That's less than the amount of damage that the warrant will suffer if the rate of leverage goes from 13% to 10% as the stock nears $20.

 

So selling today is certainly the right decision.  The total tax bill is less than what I believe will be lost by holding the warrant until $20 stock price.

 

 

Is referring to black scholes too far fetched for these warrants?

 

2 years from now

Using 20$ stock price

Exercise price 13.3

Time to maturity 4 years

Risk free rate 3%

Annual volatility 50%

 

Gives warrant's black scholes value to be 10.92

 

Leaving all other parameters same changing maturity to 5.8 years to coming back today

and stock price of 12.05 gives value to be 5.6 approx to today's price

 

http://www.mystockoptions.com/black-scholes.cfm?ticker=&s=20&x=13.3&t=4&r=3&v=50%25&calculate=Calculate

 

Thanks and

Rgds

 

 

 

 

 

[meiroy]

 

Olmsted,

 

Ericopoly wrote:

"Incidentally, those $12 strikes are non-recourse that cost 10% annualized for the leverage (higher if there are dividend increases).  So in the first couple of years, that will feel almost the same as with the warrants.  But beyond those two years (like when the stock is up at $17-$20 and beyond), the cost of $12 puts will be laughable.  And I'll defray their laughable cost by writing far out of the money calls.  For example, today the $22 strike calls cost almost the same as the $7 puts. "

 

[Parsad]

Hey Folks,

 

This thread on BAC is drifting more and more into investment strategies.  I'm going to start another board entitled "Strategies", and in there I will start another thread for you guys to continue this conversation.  I want to keep the BAC thread related to BAC news, events, etc.  So if you don't mind, please carry this discussion over on that board.  Cheers and thanks!