If you think J.P. Morgan’s stock price can rise 27% between now and Oct. 28, 2018, Uncle Sam just provided you a cheap way to make money on that bet. As part of the U.S. financial system rescue plan last year, banks that borrowed money from the Treasury also had to issue the government warrants exercisable into their common stock. J.P. Morgan issued 88.4 million warrants to the government.
These warrants were priced last night at $10.75 each and sold by the government to a group of banks that turned around and sold them to investors. The warrants are now trading at $11.28. Each warrant lets you buy a share of J.P. Morgan for $42.42 (the stock trades now around $40.80). So, for the warrants to be worth exercising, the stock needs to trade around $52.05 for an investor to break even (what you pay for the stock and what you paid for the warrants.) An investor stands to post much bigger returns by buying the warrant because it is much less expensive than the stock.
Once the stock rises about 38% (or hits around $56.50), the warrant’s returns will leap ahead. For example, if the stock is at $60, someone who bought the shares at today’s price would have recorded a 46% return. The warrant holder would have a 72% return. At $70 a share, the stock would return 71%. The warrant would return 162%.
Interestingly, the current price of the warrants also tells you two things. By trading up 54 cents from the auction price, it means the government left $47.7 million in proceeds on the table (assuming the market has put the right price on the warrants). And it tells you J.P. Morgan’s argument to pay the government less to buy these warrants back was an effort to get them on the cheap.