Stock Options and Warrants – Why You Should Pay Attention To the Exercise Price

For more information about employee stock options you should read the article How Do Stock Options Work and for more information about stock warrants I refer you to the article Where to Find a List of Outstanding Canadian Stock Warrants.

As explained in the two articles mentioned above, the easiest and quickest way to inform yourself about your stock’s outstanding stock options and warrants is by studying the company’s latest financials. In the notes related to the share capital you will find if there are any employee stock options and or stock warrants outstanding. I do not only inform myself about the in-the-money options and warrants (i.e. when the exercise prices are lower than the current share price), but I also analyse if there are any near-the-moneyoptions and warrants outstanding (i.e. when there is a very small difference between the exercise price and the current share price). All the in-the-money and near-the-money options and or warrants combined, are being referred by me as the relevant stock options and or stock warrants. Of course, I inform myself about the expiry dates as well.

A thorough analysis of your stock’s outstanding stock options and or stock warrants can lead to very useful insights. When you discover in-the-money stock options and or stock warrants owned by the company’s management, you should ask yourself why management haven’t converted them to common shares yet. Don’t they believe in the company’s future’s prospects enough to invest their own money in the company?

When management believes it’s necessary to raise additional funds, I believe it’s a good sign that management participates in the financing too, by converting their relevant stock options and or stock warrants into common shares. Even if the stock options and or stock warrants expire several years from now.

After discovering in-the-money, or near-the-money stock options and or stock warrants you should always calculate how much cash will be raised when these stock options and or stock warrants are converted into common shares.

When a stock’s management announces a private placement to cover the deficit in the company’s budget, I always compare the amount necessary with the amount which can be raised by converting management’s relevant stock options and or stock warrants into common shares. If I conclude that the private placement is unnecessary, because the required funds can also be raised by converting management’s relevant stock options and warrants, I always directly inform myself about the insider ownership percentage.

As I have determined that – depending on the stock’s market cap – corporate insiders should have a minimum share ownership, I have to calculate what the influence of this private placement will be for this minimum percentage. Then, I will ask management directly why they don’t choose to convert their relevant options and or warrants into common shares, but in stead are trying to raise the required funds by issuing additional shares. To find out how I react to management’s response, I refer you to the first note at the bottom of this page.

Another reason why I inform myself directly about the insider ownership percentage is to analyse what the new insider ownership percentage will be, if management decides to convert all their relevant stock options and or stock warrants into common shares, as I do not want the insiders to own more than 35% of the common shares.

Note: When management’s explanation is unsatisfactory, especially when management also owns a small amount of shares in the company, I will decide not to invest in this company or, when I’m already invested in this company, I will sell my holdings immediately.

Note: When I discover relevant stock options and or stock warrants which aren’t owned by the company’s management, I also inform myself about the possible effects on the insider ownership percentage, assuming that these options and warrants are converted into common shares, as I only want to invest in companies which comply with my minimum and maximum insider ownership percentage.


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