Another Way to Ride This Raging Bull Market

11/06/2013 7:00 am EST

Focus: TRADING

With markets at all-time highs, Dudley Baker of Safehaven.com thinks that now is a great time to buy these often-overlooked vehicles that can give you great ride and substantial gains.

There are days, and this is one of them, when I feel like I'm preaching to the choir about the profit potential of investing in common stock warrants. It's a small choir of successful investors, but there are few people in the pews paying attention to my sermon.

The granddaddy of investing in stock warrants was Sidney Fried, who died in 1992 at age 72. He was active from the 1950s to the 1970s, publishing a warrant survey newsletter, The RHM Warrant Survey, and writing many books about warrants-all of which I own and have studied for many years.

Despite his towering expertise about stock warrants, Fried was puzzled and frustrated that otherwise savvy investors ignored stock warrants. Today, I am an echo of that frustration. In his The Speculative Merits of Common Stock Warrants, published in 1949, Fried wrote:

"...with potential profits and potential losses so great it is a source of wonder that so little understanding of the nature of common stock warrants exists not only among the investing 'public', who might be forgive this sin, but even among the many 'professionals' of the business upon whom the 'public' depends for information and guidance."

The news of the past month reminds me of Fried's frustration. Warren Buffett made another half-billon or so because he invests in common stock warrants. This time, the warrants were with General Motors (he barely broke even here), but he made a bundle exercising his warrants for stock in Bank of America and Goldman Sachs.

It was widely publicized that Buffett made a killing again with stock warrants. So, one might wonder why other investors are not asking: "Hey Warren, what's the deal with stock warrants?"

I don't know it for a fact, but I would not be surprised to learn that Warren Buffett has studied the writings by Sidney Fried from a half-century ago.

Buffett is not alone. Other savvy investors who invest in warrants include Rick Rule, Martin Weiss, and Adam Hamilton. I was quite proud once when Hamilton called me the "guru of commodity stock warrants."

My focus had previously been on gold and silver Canadian mining exploration companies, but in May 2013 I branched out to include all sectors as well as now covering the stock warrants in the USA-mining companies, gaming, REITs, oil and gas, media, biotech, autos, and the banking and financial services companies.

What is a warrant?
A warrant is a security giving the holder the right, but not the obligation, to acquire the underlying security at a specific price and expiring on a specific date in the future. Warrants are kind of like call options; except warrants are issued by a company and they trade on the stock exchanges and have a symbol and much longer expiration dates with some issued with 3, 5, and even 10 years or more.

Why would l being buying warrants?
With stock warrants trading on companies that I like and expect to perform well in the current economic environment, I can possibly more than double my return by buying the stock warrants. In some cases, if the company is paying a dividend I will lose the dividend income, but I am going for a larger capital gain by purchasing the warrants.

Positive Aspects of long-term warrants

  • Leverage of 2-to-1 over buying the common shares
  • Substantial lower price than buying the common shares
  • A vehicle for hedging strategies using calls and puts

Unfortunately, there is a negative to warrants and that is if the common shares are trading below the exercise price of the warrant on the expiration date, then the warrants will be totally worthless. I focus on long-term warrants giving me many years before expiration and I constantly monitor the company's performance and I can sell the stock warrants any time I want if I feel the market environment has changed or the company is not meeting my expectations.

Some investors incorrectly believe that you must hold the stock warrants to the expiration date. But, investors can buy the stock warrants today and sell them tomorrow. It is that easy.

I am certainly aware that companies in the natural resource sector have performed very poorly over the last two years or so. But, I see the next few years as a great time to be in this sector with extraordinary gains possible and thus a wonderful time to be exploring the use of long-term stock warrants.

The markets in the United States are currently trading at all-time highs and many of the companies with long term warrants have performed well-giving many investors a great ride and substantial gains.

By Dudley Baker, Contributor, Safehaven.com

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