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Aug 7

Valuing Warrants under dilution

Posted by abiao at 07:17 | Code » VBA/Excel | Comments(1) | Reads(9921)
Usually, when a call option on a stock is exercised, the party with the short position acquires shares that have already been issued and sells them to the counterparty, however, warrants, executive stock options as well, are options that work slightly differently, they are written by a company on its own stock, when they are exercised, the company issues more of its own stock and sells them to the option holder for the strike price. the exercise of a warrant therefore leads to an increase in the number of shares of the company's stock that are outstanding, which has the dilution effect on the price of warrant as a result.

often we ignore this dilution effect as it might be small, here is a spreedsheet model for valuing options that result in dilution of the underlying stock if you do want to consider it.


That spreadsheet is wrong. Try valuing a high dilution warrant (i.e. lots of warrants relative to shares outstanding), with a very high exercise price (e.g. 100 times current spot price). You still get massive dilution even though the warrant if very unlikely to be exercised. When adjusting the current spot price, I believe the you need to adjust the number of warrants by the delta of those warrants.
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