Warrant Premium

A warrant works much like an option, providing the holder with the right to buy or sell a security (if they want to...the warrant holder can choose whether or not to exercise them). The warrant comes with a pre-set price, known as the exercise price.

There are two measures that get the name "warrant premium." (We know, a little confusing...like if you have two cousins named "Joey.")

The first figure measures the difference in value between the warrant's price (meaning the amount you'd have to buy the warrant in the open market) and what's called the minimum value of the underlying security (sometimes called intrinsic value).

So what's minimum value? This figure gets determined by calculating the difference between the exercise price and the current trading price for the underlying stock. If the warrant is “in the money,” meaning the exercise price is below the current trading price, the minimum value would represent the amount you could make by exercising the warrant immediately.

You have a warrant to buy 100 shares of JumpCo, maker of fine jump ropes. The exercise price of the warrant is $50 a share. Which means that, if you choose to use the warrant, you can buy 100 shares of JumpCo at $50 a share. JumpCo is currently trading at $55 a share. The minimum value is $5 a share, or $500 total for the 100 shares included in the warrant..

Say this warrant for JumpCo is selling for $700 in the open market. Then the warrant premium equals $200 (the $700 warrant price minus the $500 minimum value). Okay, that's one calculation of warrant premium.

The second way provides a variation on the same idea. It gives a percentage difference between the cost of buying the warrant versus just buying shares in the open market.

The warrant costs $700, plus the 100 shares at $50 dollars each. Buying the warrant, then immediately turning it into shares, would cost $5,700. You have to spend $700 on the warrant; then, exercising it for the shares would cost $5,000 ($50 times the 100 shares).

Meanwhile, JumpCo is trading at $55 a share. One hundred shares would cost $5,500 to buy. The warrant costs $200 more. As a percentage of the current share price, that equates to 3.6%.