Consider Bank Warrants

 | May 14, 2012 | 11:30 AM EDT
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News over the weekend that JPMorgan Chase's (JPM) trading loss is likely to exceed $2 billion continues to send shockwaves throughout the banking industry. Refusing to be fooled twice by Mr. Market, investors are selling now and asking questions later.

It's likely that JPMorgan's loss has more to do with the actions of a couple of bad traders than companywide poor risk-management. Nonetheless, the trading loss has fueled the call for more regulatory oversight, and the incident has put a dark cloud over the sector, with stock prices likely heading lower this week.

The declining share price opens a window to buy the warrants that were issued by most banks during the financial crisis. These warrants have shelf lives of many years and are becoming more attractive as share prices decline.

With exception of Wells Fargo (WFC), share prices of the major U.S. financial companies are in a multiyear bear market that, at some time, will reverse course. It's the nature of the beast.

Owning the warrants today provides an attractively priced way to benefit from a significant industry re-valuation in the coming years.

Last week at the Value Investing Congress in Omaha, a bullish thesis was presented on why American International Group (AIG) shares had an intrinsic value of $60-$70 a share vs. today's price of $31. Today, AIG warrants (AIG-WT) can be bought for $12.50 and give you the right to buy AIG shares for $45. The warrants do not expire until January 2021.

Next up is Bank of America (BAC), which has recently slipped back to $7.50 after a nice start to 2012. The company's Class A warrants (BAC-WTA) trade for $3.70 and allow you the right to buy shares for $13.30 until January 2019. The Class A warrants are much more attractive than the Class B warrants, which trade for 80 cents but have a strike price of $30.79 and expire in 2018.

Citigroup (C) also has two classes of warrants outstanding, but they are not nearly as attractive as those of Bank of America and AIG. In the case of Citim the two warrants have strike prices of $106 and $178, respectively, significantly above today's share price of $29.

Financial stocks are likely to experience volatility in the coming days and weeks. Over the past several years, it has paid off to invest in these businesses when share prices are being slashed. Patient investors are likely to find owning the warrants even more attractive.

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