Warrant prices are bounded by no-arbitrage constraints against stock prices

Evidence

Thorp and Kassouf’s 1967 book Beat the Market examined the relationship between the price of a warrant and of the underlying stock. (See figure 5.1.) No warrant should ever cost more than the underlying stock, since it is simply an option to buy the latter, and this constraint yields a “maximum value line.” If at any time the price of the stock exceeded the warrant’s strike or exercise price (the price at which it gave one the right to buy the stock) by more than the price of the warrant, an instant arbitrage profit could be made by buying the warrant, exercising it, and selling the stock thus acquired at its market price. So a warrant can never cost less than the stock price minus the strike or exercise price, and this determines the “minimum value line” in figure 5. 1. — Donald MacKenzie, An Engine, Not a Camera, 551

Categorization

• XREF: connects to: Market arbitrage requires only that investors prefer more wealth to less, not risk preferences — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 180; Early warrant pricing theory grounded market price in marginal investors’ expectations and preferences — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 537; Arbitrage enforces a real link that anchors derivatives to underlying assets — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 781 (+1 more)

Broader Connections

• Arbitrage enforces a real link that anchors derivatives to underlying assets #exemplifies (0.85) — Donald MacKenzie, An Engine, Not a Camera, 781
• Finance theory treats arbitrage as enforcing equal risk-adjusted returns #expands (0.75) — Donald MacKenzie, An Engine, Not a Camera, 1003