Uncle Sam's Gift-Wrapped Warrants

 | Dec 05, 2013 | 3:00 PM EST  | Comments
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Try to mention government, politics and investing together in any positive way, and most investors will shudder. After all, the thinking goes that government equals regulation, and that regulation harms free markets. I am not here to debate that premise. However, I will tell you that Uncle Sam has been a very supportive friend to the investor the past couple of years, and will be an ally to investors in 2014 as well. Here's why.

When the government needed to get involved in various big companies during the financial crisis, many times it received equity warrants in exchange for a capital infusion. As Uncle Sam is not in the business of owing significant stakes in U.S. corporations, those warrants have been sold back to the market. Some of these warrants are now among the highest-quality investment ideas available.

My two favorite warrants, and I own them both, are those on Bank of America (BAC) and General Motors (GM).

The Class A Bank of America warrants (see ticker symbol BAC-WTA on Yahoo! Finance) confer the right to buy BofA shares for $13.80 until January 2019. These currently trade for $6.60, while BofA shares are currently priced around $15.60. BofA is clearly on the mend, and between now and January 2019, the warrants could be worth 2x to 3x the current price.

The GM warrants I prefer are Class B (GM-WTB), which give you the right to buy GM shares for $18.33 apiece and expire on July 10, 2019. Currently GM shares trade for $39, so these warrants are more than $20 in the money. These warrants currently trade for $21.13, meaning investors are only paying $1.13 to own an option contract that expires over five years from now. You can't even buy one-year call options that deep in the money for a buck.

Other warrants courtesy of Uncle Sam include those of AIG (AIG), which don't expire until January 2021. These warrants have a strike price of $45. AIG shares trade for a hair above $48. The warrants currently trade for just under $20. If you are looking at the price of the AIG warrant in relation to the GM warrant with respect the time premium, you can see why the GM warrants look very attractive.

Warrants are longer dated options, so the ultimate value rests on how the underlying stock performs. While most options traders own shorter-term options to play off the volatility of the underlying company, these long-dated warrants should be viewed as a leveraged way to bet on the long-term performance of these businesses. If you don't believe that GM, BofA, AIG or the other companies that issued warrants will be worth significantly more in the coming years, owning the warrants may not be a good idea. That said, the trade may not be attractive in the short run, but the in the long run the upside potential is significant.

One of the shrewdest investment banks in the world, Goldman Sachs (GS), also issued warrants to Uncle Sam. What happened to them, you ask? Goldman bought them back as quickly as it could.

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