Why warrants? Why now? (November 07, 2005)

I was going to title this article, “Warrants for Dummies,” but I didn’t want to offend any readers.

However, I have come to realize that many in the investment community, including professionals, do not fully understand warrants and their advantages. They may not appear to be interested, but I believe it is merely a lack of knowledge and understanding of what a warrant is and how warrants can fit into one’s investment portfolio.

So what exactly is a warrant?

Most investors are familiar with options on stocks, calls and puts, right?

I, like many of you, realize this is a very dangerous game for most investors.

An option gives you the right, not the obligation, to acquire the underlying security/stock at a specific price and expiring at a specific date in the future.

However, options are very short term, usually 30 to 90 days, so you not only need to have good timing, but you also need to be correct with respect to the direction of the stock market. Perhaps you are a better market timer than I, but this does not work out well for most investors.

A warrant is very similar to an option but with one major difference: Time. Warrants are usually issued with a minimum of 2 to 5 years of life.

This means as investors, we have the right to acquire the underlying stock at a specific price (determined by the company) and expiring at a specific date in the future. Warrants are usually issued by companies in connection with a financial arrangement and/or public offering, and are a “kicker” to sweeten the deal.

As investors in warrants, our objective is to trade the warrants — with no intention of ever exercising them.

Warrants are all about leverage. Leverage is why an investor should be interested in warrants. If your favourite mining stock has a warrant trading, you should take a serious look to see if it fits your investment criteria — which means how much time is there before the warrant expires and does it provide good leverage?

It is not always easy to find all the facts on the warrants for some companies, but you should always do your homework — unless you allow a professional service to do it for you.

What does leverage mean? Leverage means getting the maximum return with the least amount of your investment capital at risk.

Let’s illustrate how warrants can be very profitable. One junior gold company, NovaGold Resources, has common stock that trades on the Toronto and American stock exchanges and has two warrants that trade on the TSX.

The most recent warrant issued has an exercise price of $12.10 and expires on Jan. 7, 2008.

On Sept. 23, 2005, the closing price of the common stock was $9.30 while the closing price of the recent warrant was $1.55.

If you were interested in buying 1,000 shares of the common stock, it would cost you $9,300. Or, you could instead purchase 1,000 warrants at $1.55 for a total cost of $1,550 — which would result in savings of $7,750.

Now you control 1,000 shares and have saved a lot of money.

Not only do you save money, but if the common stock goes to say, $20, (a return of 115%), the warrant will be worth at least $7.90 or a total of $7,900 on your investment of $1,550 — reflecting an incredible return of 410%.

Taking it a step further, what if, instead of buying 1,000 shares of the common stock, you invested the entire amount in the warrants? You could actually purchase 6,000 warrants for the same total cost of $9,300.

Again, if we get a move in the common stock to $20 (a 115% return), the warrants will be worth at least $7.90 or a total of $47,400 (6,000 warrants at $7.90), for a return of 410%.

This is not rocket science by any means; you just have to do the math.

With spot gold currently trading around US$464.20 per oz., many analysts believe we have broken out and are looking for US$500 gold by year’s end, for starters.

There can be little doubt that eventually all mining shares will be in a rip-roaring bull market.

Why not attempt to maximize your investment returns? An investor should consider all the ways to participate in this bull market, including adding warrants to their portfolio.

Of course, warrants do not come without some risk. If the underlying stock is trading below exercise price on the expiration date, the warrant will be worthless, which is why I strongly recommend that investors focus on warrants that have a remaining life of at least two years.

— Based in San Antonio, Tex., the author is founder of www.preciousmetalswarrants.com, a subscription service that provides complete details on all warrants of mining stocks trading in Canada and the U.S. He can be reached at info@preciousmetalswarrants.com.