OXY Warrants

Occidental Petroleum issued warrants(OXY WS) in July 2020 in lieu of dividends. The warrants exercise price is $22 and it is trading at $31.57. It can be exercised up to Aug 20,2027 and there are anti dilution provisions.

It seems to be a very cheap deep in the money call option. The Jan 2024 $23 call last traded at $30.85. So you get an additional 3.5 years to exercise the warrant for no additional premium.

Seems like a big free lunch. What am I missing?

https://www.oxy.com/globalassets/documents/investors/june202…

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The warrants exercise price is $22 and it is trading at $31.57. It can be exercised up to Aug 20,2027 and there are anti dilution provisions.

It seems to be a very cheap deep in the money call option. The Jan 2024 $23 call last traded at $30.85. So you get an additional 3.5 years to exercise the warrant for no additional premium.

Seems like a big free lunch. What am I missing?

Option prices are hard to compare precisely because they trade so much less and there is a big spread between the bid and the asking price, but with OXY shares trading at $53 right now, you can get exposure at about the same price, $22+$31 for the warrants, $23+$31 for the calls you mentioned, and $53 for the shares. So the question becomes, do I pay $31 now, plus $23 in 20 months, with the calls, or $31 now, plus $22 in 50 months, or do I pay $53 now, for 3 ways of getting the same upside exposure. With the shares, you get 0.13 per quarter in dividends, which roughly covers the interest on the extra $22-23 in capital you have to spend with the shares. On the downside, the warrants are so far in the money, at $22, that it seems unlikely the shares would trade even lower, where it would start being advantageous to have the warrants or calls instead of the shares.

It may be a free lunch, but it is small one.

The really big question, I think, is how long the current oil bonanza ($100 a barrel prices) will hold up. As a recap, the company is worth about $50b, and had operating income of $5b, $3b, -$1b and $5b in the last 4 years. But last year’s $5b was with the oil price heavily hedged, so operating income and earnings are expected to explode upwards this year. For instance, quarterly operating income last year was $0.2b and $0.6b, $1.5b and $2.3b respectively, as the hedges wore off, with all the hedges running out by the end of the year. It’s not crazy to think Occidental might have $3-4b per quarter in operating income this year, maybe more, since the company anticipated that all the hedges would have run off by the end of 2021. On the other hand, if oil prices drop back down to $50 by the end of the year, it’s not so much of a deal.

Of course, if we could predict oil prices, we wouldn’t be opining on fool.com, we would be [insert favourite pastime here]. I suspect Uncle Warren is already buying more shares hand over fist this week, so I guess that’ll be enough exposure for me that way.

dtb

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When calculating whether a warrant or long dated call is a good deal or not, the best way to do it is to compare the cost of buying the call with the cost of buying the stock.
The difference can be thought of as a loan, and the degree to which the net entry price is higher with the call can be thought of as the interest on that loan.

But…
Don’t forget that the holder of a warrant or long dated call doesn’t get any dividends.
The foregone (after tax) dividend amount expected by expiry should be added to the implied interest you’re paying for that leverage loan.

Of course, this is all just quibbling.
As DTBoojum mentioned, the real question is how long the current oil bonanza will last.
If you have a confident answer to that, there are lots and lots of ways to make good money.
And if you don’t, then going long Occidental probably isn’t such a great idea, no matter what specific security you use for the exposure.

Jim

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What if your favorite pastime is opining on fool.com?

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Do you get the dividends. while you wait until 2027?

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For US individual taxpayers, there is a difference in the treatment of exercise of warrants and equity call options.

Exercise of an equity call option is not a taxable event. It is a taxable event only when the acquired stock is sold later - LTCG or STCG.

An exercise of warrants is a taxable event. The difference between market value (average price of stock on exercise date) and the cost basis (exercise price + cost of warrant) is taxed at ordinary income rates.

This might explain why warrants are priced with less of a premium than call options.

Also it may not be as well understood and easy to value as the call option, so ignored by many traders.

I often saw this disparity with the bank TARP warrants.

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