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How to (and Why) Trade Canadian Commodity Company Warrants
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In 2009 the 46 warrants that constituted the Commodity Company Warrants Index (CCWI) were up 242% in U.S. dollar terms. With returns like that it warrants getting better educated about warrants and this article will do just that.
There are over 1000 companies of various market capitalizations trading on the Canadian and/or U.S. stock exchanges that are involved in some aspect of commodities be it mining, drilling, exploring, developing, agriculture, financing or royalty payments. Approximately 10% of those companies have warrants* that trade of which less than 4% have warrants that are of 24 months duration or longer*.
While I have written over two dozen articles on the outstanding performance of commodity related warrants in the past year vis-a-vis their associated stocks I have never given specific advice on just how to go about buying and selling such securities. As such, I have accessed the learning center of Precious Metals Warrants, checked out Canadian Warrants and also the warrants section of the Financial Post and put together an enhanced explanation on the "how" on trading in Canadian warrants as follows:
What are Warrants?
A warrant is a security giving the holder the right, but not the obligation to acquire the underlying security at a predetermined price and for a specified time.
Most warrants are on Canadian companies trading on either the S&P/TSX or the S&P/TSX Venture exchanges and, as such, it is necessary, particularly if you are an American, to have a basic knowledge of the limitations on trading in them, know how best to undertake such trades and to appreciate the enhanced returns warrants generate in a well diversified portfolio.
Limitations
Canadian investors have no restrictions on trading in warrants but that is not the case with Americans who must be cognizant of the following limitations to their doing so:
- An original issue of Canadian securities cannot be sold in the United States unless they are registered with the Securities and Exchange Commission. This means that in most cases an American can only buy Canadian securities (including warrants) after they have been issued and are trading. That limitation should not be a concern to anyone.
- An American cannot exercise a Canadian warrant unless its associated shares have been registered with the SEC because if he were to exercise the warrant he would receive a newly issued share which would not be legal. This restriction is not a problem in practice, however, because warrants can be traded like their associated stock and, as such, there is no need to exercise them.
Buying and selling warrants can be very confusing if you are not aware of the unique information required to do so and understand just how to go about it. Below I address all the information you need to know on the subject:
Symbols and CUSIP Numbers
Because warrants trade exactly like the underlying common stock they are assigned a symbol. Since most warrants* are associated with Canadian companies it is easy for Canadian investors to execute orders using their Canadian symbol*. For American investors they can use either the U.S. symbol* or the assigned OTC symbol*. A less confusing and more accurate way is to use the CUSIP number*, the legal identification that is provided for every security.
Trading Warrants
Some investors erroneously, American or otherwise, believe that you have to hold warrants until the expiration date* but that is the worst thing you can do because when they do expire they will do so without any monetary value i.e. worthless. Instead, treat the warrants as you would stocks and, when the warrants have met your financial objective, sell them with one proviso: sell the warrants well before they expire.
Exercising Warrants
It is important to note that if your warrants are "in the money", i.e. the common stock is trading above the exercise price of the warrants, and the warrants are approaching the expiration date you must take some action because, unlike call options where the value of the expired option is placed automatically into your brokerage account, that is not the case with warrants. When warrants expire they expire worth absolutely nothing!
As an American, you must sell your position before the expiration date*, and doing so at least 6 months before the expiry date would be the prudent thing to do. Indeed, you can sell your warrants at any time after you buy them as long as you don't wait until after they have expired.
As a Canadian, you have the option of either exercising the warrants (i.e. converting them into actual stock in the associated company according to the term of the warrant) once they are "in the money" or selling them outright. It all depends on whether or not you wish to continue being invested in the associated company for a longer period of time.
Should a company you hold warrants in make an offer for your warrants, via an early buy back, you have the choice to either accept the offer or sell your warrants outright unless the company had a specific early call feature (which you should have been aware of at the time of purchase) in which case you are legally obliged to sell.
Placing Orders
Warrants, like many smaller stocks, often have very thin markets i.e. demand and therefore a big spread between the bid and ask price. That being the case, it is imperative to place only “limit orders” when buying or selling warrants associated with Canadian commodity related stocks.
A cautionary note for American investors: if you go online to order you may see a price for the most recent trade that is quite possibly not the current price. If the warrant is trading with an OTC symbol the price you see will be the last trade in the U.S. which may be days, weeks or months ago. In some isolated cases the warrant will have a U.S. symbol which does not cause any concerns but if there is neither you will need to call your broker and give him/her the CUSIP number for the warrant in question. So keep in mind that the stock could be actively trading on the TSX or Venture exchanges in Canada but not in the U.S. Do not be discouraged. Ascertain the current price of the shares in Canadian dollars, decide how much you want to pay for the shares (in U.S. Dollars) and enter your "limit order" (see ‘Dealing with Brokers’ below).
Assessing Company Mergers or Buyouts
In a stock exchange arrangement, the warrants will continue on as warrants of the acquiring company with the same expiration date and with the exercise terms adjusted to reflect the terms of the stock exchange in the merger. The owner of said warrants will want to assess the prospects of the new owner to assess the upside potential of their 'new' warrants and if the assessment is not positive to sell out before others come to the same conclusion.
Dealing With Brokerage Firms
As there are symbols for all Canadian warrants Canadians will find the placing of orders very easy to execute and, as such, possible to use an online brokerage firm if so inclined. Be that as it may, please make note in the last paragraph in this section how 'exactly' to go about placing your order with a broker.
The situation is not so straight forward for those individuals using non-Canadian brokerage houses. Because many online brokers are not set up with the symbols for the warrants you wish to trade it may be necessary to deal with a broker and have him/her enter the order. In most cases the broker will usually have to call his/her back office or clearing firm to get the correct symbol for placing the order so the most important thing you can do to help the broker is to give him/her the CUSIP number for the warrants you wish to purchase.
While virtually all brokerage firms will execute trades in warrants you may find, believe it or not, that your broker may need to be educated on how to go about it. As such, never 'ask' your broker if they will execute your orders for warrants but, instead, 'tell' them exactly what you want them to do. If you just 'ask' many brokers will say they don't trade in Canadian warrants so they can't execute the order. However, if you 'tell' them exactly what you want them to do on your behalf most will be more than happy to comply.
Here's an example of how you should go about placing an order for 10,000 warrants on XYZ Mining Company with a CUSIP number of 987654321 and warrants that expire on June 7th, 2015 and you want to limit the price you pay in U.S. Dollars to $0.55. Give your broker these specific instructions: "I want to buy 10,000 XYZ Mining Company warrants, CUSIP number - 987654321, expiring on June 7th, 2015 at a 'limit price' of $0.55 U.S. dollars". Your broker will read the order back to you for confirmation and it's done - as simple as that!
Why Bother Investing in Warrants
In 2009 the 46 warrants that constituted the Commodity Company Warrants Index (CCWI) were up 242% in U.S. dollar terms and the stock of their associated 35 companies (the CCI) were up 126% . With returns like that it warrants getting better educated about warrants and now you are!
*See the "List of Commodity Companies Index (CCI) Constituents" article in the 'Warrants/LEAPS/Options' category at www.MunKnee.com for a list of all commodity related warrants complete with their Canadian/U.S symbols; OTC symbols; CUSIP numbers and expiry dates. Said list will be updated on a weekly basis.
Lorimer Wilson
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Lorimer Wilson is Editor of www.FinancialArticleSummariesToday.com (F.A.S.T.) and www.MunKnee.com (Money, Monnee, Munknee!) and an economic analyst and financial writer. He is also a frequent contributor to this site and can be reached at editor@munknee.com."
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