A warrant gives you the right but not the obligation to purchase a share at a predetermined price. Very similar to how options work. Say you bought a warrant for $2 that lets you buy a stock of company X at a strike price of $11.50, if the price of company X reaches $20. Exercising your warrant would let you buy a share of company X at $11.50 and sell it at $20. Giving you a profit of $8.50 minus $2 (the price you bought the warrant for). This gives you a return on investment of 325%.
Compare this to a scenario where instead you buy a share of company X (a SPAC pre merger). You would buy company X for roughly $11 and sell it for $20 giving you a return on investment of 82%. This highlights how warrants can give you better returns on SPACs. However there is also a higher risk.
In another scenario where company X is a SPAC that never merged, your investment in the common stock of company X gives you an approximate 10% loss as the value of company X falls from $11 to $10 (the floor for SPACs), However your warrants become completely worthless losing you any money invested.
Things to Consider
Warrants can’t be exercised right away – Usually warrants can only be exercised 30 days after the merger or a year after the SPAC IPO. This means if the price of the SPAC shoots up based on speculation of a merger but sufficient time hasn’t passed you won’t be able to exercise the warrant.
Only whole warrants can be exercised – You can’t exercise 1/2 a warrant. Which is sometimes the portion of the warrant offered in Units on a SPAC’s IPO. You would have to buy another 1/2 to have enough to exercise or just sell your 1/2 for a profit.
Ratios of warrants – most warrants have a 1:1 ratio between the warrant and how much common stock you get when exercising a warrant but not all do. Many have a 2:1 ratio so you would need 2 warrants for the right to buy 1 common stock at the pre-determined strike price. And some even have a 4:3 ratio in which you need 4 warrants for 3 common stocks. You will have to verify the ratio for the SPAC your looking to invest in.
You need enough capital to exercise a warrant – If you own 100 warrants with a strike price of $11.50 and you wish to exercise them to profit off the current stock price being higher than $11.50, You need 100 x $11.50 to exercise the 100 warrants. You cannot exercise the warrants without the money to buy the underlying stock in the first place. If you don’t have the money required you can still just sell the warrants and make a profit.
Cash redemption – If the price of the underlying stock remains above a certain price for a certain amount of time this usually gives the company the right to redeem the warrants. Usually the price of the stock would have to remain above $18 for 20 of 30 consecutive days. In a cash redemption the company offers a nominal consideration for the warrants (e.g. 0.01 per warrant) this forces public warrants to be exercised or lose immense value. If you hold them passed the expiration date of the early redemption call they become essentially worthless.
Cashless redemption – Most redemption calls are cash redemptions but in rare cases a company may have a cashless redemption. In a cashless redemption your warrants automatically convert into the equivalent value of stock. In this conversion there is a standard formulae used so for the investor they get as much value as if the warrants were exercised. But in this scenario the company doesn’t receive the $11.50 they usually would in a cash redemption, so they reduce the cash generated but they also reduce share dilution. As a whole new stock being offered per warrant in the warrants being exercised adds more stocks to the market than the fraction of a share given out per warrant in a cashless redemption. Although this is more rare as companies post merger usually still prefer to raise money.
Do warrants convert to the new company when SPACs merge? Yes, a warrant of the SPAC becomes a warrant of the new company post merger.
Do I have to exercise them? No, You can trade the warrants on the market. They are very liquid which adds to their appeal.
Do I have to hold them through merger? No, you can always just trade them on the market at any time.
What if I don’t have the money to exercise the warrant? Your best option is to sell the warrant. Or if you have many warrants you can sell some of them until you have the capital required to exercise the rest.
How do I exercise warrants? This varies across brokers. You will have to call your broker to find out how to exercise the warrants and whether your particular broker even allows you to purchase warrants in the first place.