BAC leverage

[ERICOPOLY]

And that's why the warrant gets incrementally riskier as you tack on more years with the same cost of leverage for each successive year.

 

We started off this thread with the 2 yr options priced with the same relatively high annual cost of leverage as the 6 yr warrants.

 

That was the key thing... the annual cost should have been a lot lower for the added years in the warrants to compensate for the risk from skewness.

[gary17]

How are you guys calculating the 'cost of leverage'  -  sorry, I know this has been discussed.... and the search function here isn't powered by Google..... 

 

I look at it like this....

 

Warrant closed at $7.13.  Strike is $13.24  so total implied cost is $20.37 

 

The commons are at $17.68  so the cost of leverage from now until Jan 2019 is $20.37 / $17.68 - 1 = 15%  or about 3.75% per year.    I see the "5%" written before.. .just not sure how that's calculated.

 

I believe the puts are about 2.5% ? and if one borrows money at 1% ... seems fairly comparable now.

 

Gary

 

 

 

 

 

[ERICOPOLY]

How are you guys calculating the 'cost of leverage'  -  sorry, I know this has been discussed.... and the search function here isn't powered by Google..... 

 

I look at it like this....

 

Warrant closed at $7.13.  Strike is $13.24  so total implied cost is $20.37 

 

The commons are at $17.68  so the cost of leverage from now until Jan 2019 is $20.37 / $17.68 - 1 = 15%  or about 3.75% per year.    I see the "5%" written before.. .just not sure how that's calculated.

 

I believe the puts are about 2.5% ? and if one borrows money at 1% ... seems fairly comparable now.

 

Gary

 

You subtract warrant price from stock price.

The remainder compounds up to the warrant strike at a rate.  Add the missed 1 cent quarterly dividend expressed as a percentage of strike.

 

You're done -- that is the cost of leverage.

[gary17]

How are you guys calculating the 'cost of leverage'  -  sorry, I know this has been discussed.... and the search function here isn't powered by Google..... 

 

I look at it like this....

 

Warrant closed at $7.13.  Strike is $13.24  so total implied cost is $20.37 

 

The commons are at $17.68  so the cost of leverage from now until Jan 2019 is $20.37 / $17.68 - 1 = 15%  or about 3.75% per year.    I see the "5%" written before.. .just not sure how that's calculated.

 

I believe the puts are about 2.5% ? and if one borrows money at 1% ... seems fairly comparable now.

 

Gary

 

You subtract warrant price from stock price.

The remainder compounds up to the warrant strike at a rate.  Add the missed 1 cent quarterly dividend expressed as a percentage of strike.

 

You're done -- that is the cost of leverage.

 

So with more dividends over one cent the cost of leverage is getting cheaper... as the strike is adjusted down.

 

What happens when the difference in stock and warrant price exceeds the strike. Would that happen? Negative cost of leverage???

[ERICOPOLY]

How are you guys calculating the 'cost of leverage'  -  sorry, I know this has been discussed.... and the search function here isn't powered by Google..... 

 

I look at it like this....

 

Warrant closed at $7.13.  Strike is $13.24  so total implied cost is $20.37 

 

The commons are at $17.68  so the cost of leverage from now until Jan 2019 is $20.37 / $17.68 - 1 = 15%  or about 3.75% per year.    I see the "5%" written before.. .just not sure how that's calculated.

 

I believe the puts are about 2.5% ? and if one borrows money at 1% ... seems fairly comparable now.

 

Gary

 

You subtract warrant price from stock price.

The remainder compounds up to the warrant strike at a rate.  Add the missed 1 cent quarterly dividend expressed as a percentage of strike.

 

You're done -- that is the cost of leverage.

 

So with more dividends over one cent the cost of leverage is getting cheaper... as the strike is adjusted down.

 

What happens when the difference in stock and warrant price exceeds the strike. Would that happen? Negative cost of leverage???

 

No.

 

That's just anti-dilution stuff to simulate a reinvested dividend.  It doesn't affect cost of the leverage.

 

In a margined account, your margin interest rate is the same whether or not you get a dividend that you reinvest.  Same thing with the warrants.

[gary17]

How are you guys calculating the 'cost of leverage'  -  sorry, I know this has been discussed.... and the search function here isn't powered by Google..... 

 

I look at it like this....

 

Warrant closed at $7.13.  Strike is $13.24  so total implied cost is $20.37 

 

The commons are at $17.68  so the cost of leverage from now until Jan 2019 is $20.37 / $17.68 - 1 = 15%  or about 3.75% per year.    I see the "5%" written before.. .just not sure how that's calculated.

 

I believe the puts are about 2.5% ? and if one borrows money at 1% ... seems fairly comparable now.

 

Gary

 

You subtract warrant price from stock price.

The remainder compounds up to the warrant strike at a rate.  Add the missed 1 cent quarterly dividend expressed as a percentage of strike.

 

You're done -- that is the cost of leverage.

 

So with more dividends over one cent the cost of leverage is getting cheaper... as the strike is adjusted down.

 

What happens when the difference in stock and warrant price exceeds the strike. Would that happen? Negative cost of leverage???

 

No.

 

That's just anti-dilution stuff to simulate a reinvested dividend.  It doesn't affect cost of the leverage.

 

In a margined account, your margin interest rate is the same whether or not you get a dividend that you reinvest.  Same thing with the warrants.

 

Thanks, got it! I think this is the second time you've explained this to me. Appreciate your patience with me on this!

[ERICOPOLY]

How are you guys calculating the 'cost of leverage'  -  sorry, I know this has been discussed.... and the search function here isn't powered by Google..... 

 

I look at it like this....

 

Warrant closed at $7.13.  Strike is $13.24  so total implied cost is $20.37 

 

The commons are at $17.68  so the cost of leverage from now until Jan 2019 is $20.37 / $17.68 - 1 = 15%  or about 3.75% per year.    I see the "5%" written before.. .just not sure how that's calculated.

 

I believe the puts are about 2.5% ? and if one borrows money at 1% ... seems fairly comparable now.

 

Gary

 

You subtract warrant price from stock price.

The remainder compounds up to the warrant strike at a rate.  Add the missed 1 cent quarterly dividend expressed as a percentage of strike.

 

You're done -- that is the cost of leverage.

 

So with more dividends over one cent the cost of leverage is getting cheaper... as the strike is adjusted down.

 

What happens when the difference in stock and warrant price exceeds the strike. Would that happen? Negative cost of leverage???

 

No.

 

That's just anti-dilution stuff to simulate a reinvested dividend.  It doesn't affect cost of the leverage.

 

In a margined account, your margin interest rate is the same whether or not you get a dividend that you reinvest.  Same thing with the warrants.

 

Thanks, got it! I think this is the second time you've explained this to me. Appreciate your patience with me on this!

 

I don't blame you.  Some bloggers have spread some weird mumbo-jumbo about the anti-dilution provisions as if they are some big secret that the market doesn't understand and thus have some secret hidden value that only the dedicated prospectus readers (like themselves of course) could know about.

 

I have been quietly laughing at them from time to time because the very same prospectus clearly states it to be anti-dilutive provisioning.  So did they in fact read it  ::)

[Mephistopheles]

How are you guys calculating the 'cost of leverage'  -  sorry, I know this has been discussed.... and the search function here isn't powered by Google..... 

 

I look at it like this....

 

Warrant closed at $7.13.  Strike is $13.24  so total implied cost is $20.37 

 

The commons are at $17.68  so the cost of leverage from now until Jan 2019 is $20.37 / $17.68 - 1 = 15%  or about 3.75% per year.    I see the "5%" written before.. .just not sure how that's calculated.

 

I believe the puts are about 2.5% ? and if one borrows money at 1% ... seems fairly comparable now.

 

Gary

 

You subtract warrant price from stock price.

The remainder compounds up to the warrant strike at a rate.  Add the missed 1 cent quarterly dividend expressed as a percentage of strike.

 

You're done -- that is the cost of leverage.

 

So with more dividends over one cent the cost of leverage is getting cheaper... as the strike is adjusted down.

 

What happens when the difference in stock and warrant price exceeds the strike. Would that happen? Negative cost of leverage???

 

No.

 

That's just anti-dilution stuff to simulate a reinvested dividend.  It doesn't affect cost of the leverage.

 

In a margined account, your margin interest rate is the same whether or not you get a dividend that you reinvest.  Same thing with the warrants.

 

Thanks, got it! I think this is the second time you've explained this to me. Appreciate your patience with me on this!

 

I don't blame you.  Some bloggers have spread some weird mumbo-jumbo about the anti-dilution provisions as if they are some big secret that the market doesn't understand and thus have some secret hidden value that only the dedicated prospectus readers (like themselves of course) could know about.

 

I have been quietly laughing at them from time to time because the very same prospectus clearly states it to be anti-dilutive provisioning.  So did they in fact read it  ::)

 

Lol the blogger whom you are referring to also posts on this board! :-X

[ERICOPOLY]

How are you guys calculating the 'cost of leverage'  -  sorry, I know this has been discussed.... and the search function here isn't powered by Google..... 

 

I look at it like this....

 

Warrant closed at $7.13.  Strike is $13.24  so total implied cost is $20.37 

 

The commons are at $17.68  so the cost of leverage from now until Jan 2019 is $20.37 / $17.68 - 1 = 15%  or about 3.75% per year.    I see the "5%" written before.. .just not sure how that's calculated.

 

I believe the puts are about 2.5% ? and if one borrows money at 1% ... seems fairly comparable now.

 

Gary

 

You subtract warrant price from stock price.

The remainder compounds up to the warrant strike at a rate.  Add the missed 1 cent quarterly dividend expressed as a percentage of strike.

 

You're done -- that is the cost of leverage.

 

So with more dividends over one cent the cost of leverage is getting cheaper... as the strike is adjusted down.

 

What happens when the difference in stock and warrant price exceeds the strike. Would that happen? Negative cost of leverage???

 

No.

 

That's just anti-dilution stuff to simulate a reinvested dividend.  It doesn't affect cost of the leverage.

 

In a margined account, your margin interest rate is the same whether or not you get a dividend that you reinvest.  Same thing with the warrants.

 

Thanks, got it! I think this is the second time you've explained this to me. Appreciate your patience with me on this!

 

I don't blame you.  Some bloggers have spread some weird mumbo-jumbo about the anti-dilution provisions as if they are some big secret that the market doesn't understand and thus have some secret hidden value that only the dedicated prospectus readers (like themselves of course) could know about.

 

I have been quietly laughing at them from time to time because the very same prospectus clearly states it to be anti-dilutive provisioning.  So did they in fact read it  ::)

 

Lol the blogger whom you are referring to also posts on this board! :-X

 

Excellent, this gives the blogger a chance to clear up the misleading information.

[rpadebet]

Eric,

I know this is the BAC thread and your explanation of skew makes sense, but I would like to know your thoughts on what happened to AIG warrants this year.

 

This is a real trade:

Feb 11, 2014:

AIG Stk: $49

AIG Warrant (7 yrs apprx @45 strike): $19

Cost of Lev: 4.8%

 

Dec 8, 2014:

AIG Stk: $55.5

AIG Warrant (6 yrs apprx @45 strike): $24.5

Cost of Lev: 5.2%

 

Stk return: 13.3%

Warrant return: 29%

 

 

The term is longer than most warrants, so as per your posts skew risk should be higher. The stock moved away from the strike, so cost of lev should have fallen theoretically, but it went up. Time to maturity reduced, cost of lev should have fallen, but it went up. VIX was higher in Feb compared to now, so again cost of lev should be lower now, but it is up.

 

How would you explain this? Is this a chance happening or is there more to this?

 

Btw, 5.2% avg cost over 6 yrs is a lot for me, so I rolled into LEAPs today anyway (3.5% ish) ;D

 

[ERICOPOLY]

Eric,

I know this is the BAC thread and your explanation of skew makes sense, but I would like to know your thoughts on what happened to AIG warrants this year.

 

This is a real trade:

Feb 11, 2014:

AIG Stk: $49

AIG Warrant (7 yrs apprx @45 strike): $19

Cost of Lev: 4.8%

 

Dec 8, 2014:

AIG Stk: $55.5

AIG Warrant (6 yrs apprx @45 strike): $24.5

Cost of Lev: 5.2%

 

Stk return: 13.3%

Warrant return: 29%

 

 

The term is longer than most warrants, so as per your posts skew risk should be higher. The stock moved away from the strike, so cost of lev should have fallen theoretically, but it went up. Time to maturity reduced, cost of lev should have fallen, but it went up. VIX was higher in Feb compared to now, so again cost of lev should be lower now, but it is up.

 

How would you explain this? Is this a chance happening or is there more to this?

 

Btw, 5.2% avg cost over 6 yrs is a lot for me, so I rolled into LEAPs today anyway (3.5% ish) ;D

 

For one thing, arguing that a higher VIX should spike the premium for AIG is like arguing that AIG's stock price should move in lockstep with the S&P500.  Or how come PWE stock is down 11% if the oil stocks index is down much less.

 

Interest rate expectations could have an effect both on AIG's stock volatility as it effects both their book value as well as interest income, as well as insurance pricing.  Interest rate expectations are also a component of the pricing for the synthetic leverage in the warrant.

 

That was also a quite small put premium to begin with, so skewness on a 13% stock price jump may not necessarily be the dominant factor in the pricing if interest rate expectations change.

 

There is also likely to be movements in the warrant price from randomness.

 

 

[ERICOPOLY]

The warrants having made a move down to $2 doesn't prove anything because you were not wiped out owning them, whereas being wiped-out is exactly the risk I'm talking about.

 

I don't characterize rolling my initial position into the $2 warrant a "wipe out" when the "something" was purchased for far less than the observable decline in the warrants.

 

I want that to happen!  It was the whole point of the defensively minded strategy. 

 

[ni-co]

Yes, and I question the wisdom of doing that. What would your "cost of leverage" be once you'd lost your whole investment at some point in time?

 

It doesn't change the cost of leverage.

 

Just like the interest expense that Fairfax incurs on the bonds used to finance the buyout of ORH.  They lose 100% of the interest costs.  Same with at-the-money LEAPS premium.  Return realized on the underlying investment isn't a cost of the leverage.

 

To me this goes back to the question of why Eric is ignoring the implied put value of the warrants.

 

And you base this statement of non-fact on what?  This entire thread is dedicated to the valuation of the non-recourse leverage.  The put is the "non". 

 

That's why I compare it to put+margin versus margin alone.  Yeah, I see, you think I do that BECAUSE I'm ignoring that the warrant also has a put component.  Nice! :)

 

 

So what's the point in owning the levered equity and a put over the warrant?

 

To avoid the expected massacre of the embedded put due to skewness if the common stock price moves sharply away from the strike price of the warrant's put.  And... given that it was at-the-money to begin with, the hit will be most severe and only negative (it can only move further from strike).

 

Eric, I think we agree that securing levered equities by a put with 5 years to expiration won't be cheaper than owning the warrant, right?

 

Detract the implied put value from the warrant and your implied interest rate is going to be the ~5y risk free rate plus the market's best guess of the amount of dividends paid. A put with 5 years to expiry date is worth a lot. This is what I meant with "ignoring the implied put value".

 

If we agree on that, I'm trying to explain better why I think that your "cost of leverage" way of looking at the warrant doesn't add clarity. The "expensive" implied put is the reason why the warrants have a high "cost of leverage" attached to them. So comparing levered equities secured by 2y puts is an apples to oranges comparison.

 

What I wanted to say is that there is no free lunch here. The "cost of leverage" of shorter duration calls (or puts for that matter) is cheaper because they are riskier.

 

Now, you are of the opinion that BAC is going to make a large move within the next 12 months or so. Of course, it's cheaper not to pay up for the additional duration in this case. But you are speculating on this move. Your cost of leverage will be even lower when you expect BAC to move within the next three months. Why pay up for the LEAPs? This way of looking at it just makes no sense, because you are presuming a certain stock price movement within a certain time frame. The way you put it, though, is as if the LEAPs were cheap and the warrants expensive in an absolute sense and this is simply not true. This is what I mean with "glossing over the risk". The warrants having made a move down to $2 doesn't prove anything because you were not wiped out owning them, whereas being wiped-out is exactly the risk I'm talking about.

 

I'm coming back to the bond analogy: Your cost of leverage theory is like saying long duration bonds are a better investment than short duration bonds because the interest payment is higher. Well, this might be true in certain environments, but there is a reinvestment risk with shorter duration bonds. It's exactly the same thing with shorter duration LEAPs vs. longer duration warrants. There is no free lunch here.

 

I understand what you mean with "skewdness" but this is just a fancy way of saying that you expect the price action to occur within a shorter time frame. You are thereby taking more risk than somebody who gives BAC more time to work out. Of course, your return will be better if you are right, but it will be worse if BAC moves downwards or fluctuates wildly around the strike price.

 

[EDIT: Sorry, I wanted to rephrase it a bit. This is why I deleted the old post.]

[ERICOPOLY]

Now, you are of the opinion that BAC is going to make a large move within the next 12 months or so. Of course, it's cheaper not to pay up for the additional duration in this case. But you are speculating on this move.

 

Don't think about risk so linearly.  My strategy isn't locking the put strike at $12 for the entire term.

 

The $17 strike put now costs less than what you paid for your $13.30 strike put.

 

I can roll into it and guarantee to have made a profit, while you are still keeping your position at risk of total wipeout should the stock drop again and not recover before expiry..

 

 

[ni-co]

Now, you are of the opinion that BAC is going to make a large move within the next 12 months or so. Of course, it's cheaper not to pay up for the additional duration in this case. But you are speculating on this move.

 

Don't think about risk so linearly.  My strategy isn't locking the put strike at $12 for the entire term.

 

The $17 strike put now costs less than what you paid for your $13.30 strike put.

 

I can roll into it and guarantee to have made a profit, while you are still keeping your position at risk of total wipeout should the stock drop again and not recover before expiry..

 

No, this is exactly what you couldn't have done – you couldn't have guaranteed it. You can do it now because (1) the stock price went up and (2) volatility went down. If it were exactly the opposite, believe me this put you'd want to roll into would be darn expensive.

[ERICOPOLY]

Now, you are of the opinion that BAC is going to make a large move within the next 12 months or so. Of course, it's cheaper not to pay up for the additional duration in this case. But you are speculating on this move.

 

Don't think about risk so linearly.  My strategy isn't locking the put strike at $12 for the entire term.

 

The $17 strike put now costs less than what you paid for your $13.30 strike put.

 

I can roll into it and guarantee to have made a profit, while you are still keeping your position at risk of total wipeout should the stock drop again and not recover before expiry..

 

No, this is exactly what you couldn't have done – you couldn't have guaranteed it. You can do it now because (1) the stock price went up and (2) volatility went down. If it were exactly the opposite, believe me this put you'd want to roll into would be darn expensive.

 

And what if the dog jumped over the fence?

 

Stock went up on falling uncertainty -- a recipe for soaring volatility. (sarcasm)

[ni-co]

Now, you are of the opinion that BAC is going to make a large move within the next 12 months or so. Of course, it's cheaper not to pay up for the additional duration in this case. But you are speculating on this move.

 

Don't think about risk so linearly.  My strategy isn't locking the put strike at $12 for the entire term.

 

The $17 strike put now costs less than what you paid for your $13.30 strike put.

 

I can roll into it and guarantee to have made a profit, while you are still keeping your position at risk of total wipeout should the stock drop again and not recover before expiry..

 

No, this is exactly what you couldn't have done – you couldn't have guaranteed it. You can do it now because (1) the stock price went up and (2) volatility went down. If it were exactly the opposite, believe me this put you'd want to roll into would be darn expensive.

 

And what if the dog jumped over the fence?

 

Stock went up on falling uncertainty -- a recipe for soaring volatility.

 

Yes. It went well. So there couldn't have been a risk, I guess. I think we just can agree to disagree on this one.

 

ps: The irony of this whole discussion is that my BAC position was 50% LEAPs (and 50% warrants, of course).

[ERICOPOLY]

Now, you are of the opinion that BAC is going to make a large move within the next 12 months or so. Of course, it's cheaper not to pay up for the additional duration in this case. But you are speculating on this move.

 

Don't think about risk so linearly.  My strategy isn't locking the put strike at $12 for the entire term.

 

The $17 strike put now costs less than what you paid for your $13.30 strike put.

 

I can roll into it and guarantee to have made a profit, while you are still keeping your position at risk of total wipeout should the stock drop again and not recover before expiry..

 

No, this is exactly what you couldn't have done – you couldn't have guaranteed it. You can do it now because (1) the stock price went up and (2) volatility went down. If it were exactly the opposite, believe me this put you'd want to roll into would be darn expensive.

 

And what if the dog jumped over the fence?

 

Stock went up on falling uncertainty -- a recipe for soaring volatility.

 

Yes. It went well. So there couldn't have been a risk, I guess. I think we just can agree to disagree on this one.

 

No risk?  What the heck?  Are you just fucking with me for laughs?

 

The risk to my strategy is the exact one I laid out way before you first posted on this thread -- that the stock would remain tight around the $12 range.

 

The warrant strategy had the risks from skewness and fixed-strike, unable to lock in gains as they come.

 

 

 

[ERICOPOLY]

What I wanted to say is that there is no free lunch here. The "cost of leverage" of shorter duration calls (or puts for that matter) is cheaper because they are riskier.

 

I've never seen that before.  Please provide an example.

 

I've only found the opposite to be true.

[ni-co]

No risk?  What the heck?  Are you just fucking with me for laughs?

 

No, I don't do that. I'm sorry that it came over this way.

 

The risk to my strategy is the exact one I laid out way before you first posted on this thread -- that the stock would remain tight around the $12 range.

 

The warrant strategy had the risks from skewness and fixed-strike, unable to lock in gains as they come.

 

There is no need to get angry. I know that you mentioned the risks. Don't get me wrong, I didn't say that it was a bad strategy. It was a nice risk/reward pay-off. My whole point – that you seemingly won't accept – is that there is no point in talking about the "cost of leverage" as if you were comparing a cheap loan to an expensive one. This is an apples to oranges comparison with a different risk profile. You can compare it from an expected risk/reward perspective but you can't just point to the price (a.k.a. the "cost of leverage") of any of those options and simply say: this one is cheap and this one is expensive.

[ERICOPOLY]

You can compare it from an expected risk/reward perspective but you can't just point to the price (a.k.a. the "cost of leverage") of any of those options and simply say: this one is cheap and this one is expensive.

 

Semantics.  Under that language, a stock with a huge margin of safety cannot be called "cheap".

 

The warrants didn't have a margin of safety priced in.  I'm happy to rephrase it as such.

 

The 2 yr options had the same cost of leverage as the 6 yr warrant.  No pricing discount for skewness risk.  This was a volatile stock.  I would characterize the warrant as having been overvalued.

[gary17]

Hi Eric

I realize you indicated that the strike adjustment for the warrants is simply so that the warrant holders don't get diluted...  But if I look at this formula ,

 

warrant price = BAC commons - strike of $13.26 + total dividend above $0.01

 

I can't help but wondering, just mathematically, warrant holders seem to benefit more. 

 

If we assume the common is at $25 and the dividend paid is $1.  Before the payment of dividend, Warrant should be

 

$25 - 13.26 = $11.74

 

After the $1 dividend the warrants should be worth $25 - $13.26 + 1 = $12.74

 

That's a $12.74 / $11.74 = 8% gain

 

For the common holder, they are making $1 / $25 = 4% only. 

 

So while the intent of the strike adjustment is for anti-dilution; in my mind the 'benefit' is given to the warrant holders up front because they technically haven't paid the money to actually own the full BAC commons yet...  Perhaps this is the flawed way of thinking that you mentioned.  But I'm seeing it like this....

 

Gary

[racemize]

Hi Eric

I realize you indicated that the strike adjustment for the warrants is simply so that the warrant holders don't get diluted...  But if I look at this formula ,

 

warrant price = BAC commons - strike of $13.26 + total dividend above $0.01

 

I can't help but wondering, just mathematically, warrant holders seem to benefit more. 

 

If we assume the common is at $25 and the dividend paid is $1.  Before the payment of dividend, Warrant should be

 

$25 - 13.26 = $11.74

 

After the $1 dividend the warrants should be worth $25 - $13.26 + 1 = $12.74

 

That's a $12.74 / $11.74 = 8% gain

 

For the common holder, they are making $1 / $25 = 4% only. 

 

So while the intent of the strike adjustment is for anti-dilution; in my mind the 'benefit' is given to the warrant holders up front because they technically haven't paid the money to actually own the full BAC commons yet...  Perhaps this is the flawed way of thinking that you mentioned.  But I'm seeing it like this....

 

Gary

 

That's not how the formula works for the warrant adjustment.  The adjustment is based on the dividend to common ratio--at some point in this forum we talked about this and showed that it was the same as dividend reinvestment, but I don't recall where.  It's worth doing the math to prove it to yourself though.

[CorpRaider]

Yeah eric esplained it to me in really clear terms just a page or two back, i believe.

[ERICOPOLY]

Hi Eric

I realize you indicated that the strike adjustment for the warrants is simply so that the warrant holders don't get diluted...  But if I look at this formula ,

 

warrant price = BAC commons - strike of $13.26 + total dividend above $0.01

 

I can't help but wondering, just mathematically, warrant holders seem to benefit more. 

 

If we assume the common is at $25 and the dividend paid is $1.  Before the payment of dividend, Warrant should be

 

$25 - 13.26 = $11.74

 

After the $1 dividend the warrants should be worth $25 - $13.26 + 1 = $12.74

 

That's a $12.74 / $11.74 = 8% gain

 

For the common holder, they are making $1 / $25 = 4% only. 

 

So while the intent of the strike adjustment is for anti-dilution; in my mind the 'benefit' is given to the warrant holders up front because they technically haven't paid the money to actually own the full BAC commons yet...  Perhaps this is the flawed way of thinking that you mentioned.  But I'm seeing it like this....

 

Gary

 

The warrant is a synthetically leveraged portfolio.  You are comparing it to unleveraged portfolio of common.

 

A $1 price movement results in a higher % impact when leveraged vs unleveraged.

 

So instead, compare it to a leveraged common stock portfolio.  Use the same degree of leverage as the warrant.