The Risks of Buying a Warrant and of Buying the Underlying Stock
When a stock price rises, the price of a warrant for the stock often rises more steeply. The rise of the warrant price can be two, three, or more times the increase in the stock price. When a stock price decreases, however, the drop in the warrant price is often more extreme. The warrant may even become worthless.
Example: A warrant price rises
Assume that a warrant for American Bio Medica stock was purchased on March 17, 2006 for $0.20, and the stock price triples from $0.97 to $2.91 per share.
In this case, the warrant price will jump from $0.20 to $1.86, which represents a 9.3-fold increase. No one will sell their warrant for less than that price because they can exercise it at $1.05 per share, and afterward sell their newly acquired stock for $2.91.
Example: A warrant price falls
In the previous example, let us assume that the stock price fell from $0.97 to $0.485. In this case, the warrant price falls from $0.20 to 0. Nobody is willing to pay anything for a warrant allowing them the “right” to pay $1.05 (the exercise premium) for a stock that can be bought on the market for $0.485.
Note that even if the stock price remains at $0.97, the warrant price will fall to 0 as the expiration date approaches.