Re: Valuing warrants
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If its an IPO, how do you decide what volatility to you use as an input?
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you can really only use a proxy, and scholes is ballpark estimate at best anyways.
we never used black scholes really, other than for academic reasons. just traded both by feel, generally got long the warrants and shorted some common as a hedge. depending on how bullish you were on the company you could adjust your hedge accordingly. Common ratios were 2:1 or 3:1. As warrants got further out of the money we would up the ratio as they got closer to the money/in the money we would decrease the ratio.
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if you were heding your exposure to stock movement, if a stock IP0s at $12 and you are only selling 1/4 - 1/3rd of to hedge your exposure for a 3 year option with a $13.5 strike you are very likely actually long the stock and not really hedged. seems like the delta of this option has to be far higher than $50, given the fact that the forward price is going to be right around $13.5.
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