Rights offerings give existing shareholders the opportunity to buy additional shares at a discounted price before the company offers them to the public. Understanding how to trade these events can help you protect your investment or even profit from the situation.
What is a Rights Offering?
A rights offering (also called a rights issue) is when a company raises capital by giving existing shareholders the right to purchase new shares at a discount to the current market price. The rights are issued proportionally based on your current holdings and typically must be exercised within a set timeframe.
Key concept: If you own 100 shares and the company issues rights to buy 1 additional share for every 5 shares owned at a 20% discount, you would receive rights to buy 20 additional shares at below-market prices.
Why Companies Do Rights Offerings
Rights offerings are used to raise capital while giving existing shareholders the first opportunity to maintain their ownership percentage:
- Raise capital: Fund expansion, acquisitions, or pay down debt
- Avoid dilution for existing shareholders: Shareholders can buy more shares to maintain their percentage ownership
- Lower cost than public offerings: Rights offerings have lower underwriting fees
- Strengthen shareholder loyalty: Rewards existing shareholders with discounted pricing
How Rights Offerings Work
The typical rights offering process includes these steps:
- Announcement: Company announces the rights offering with terms and pricing
- Record date: You must own shares by this date to receive rights
- Rights distribution: Rights certificates are credited to shareholder accounts
- Subscription period: Timeframe during which rights can be exercised (usually 2-4 weeks)
- Expiration: Unexercised rights become worthless after this date
- New share issuance: New shares are delivered to shareholders who exercised rights
Your Options When You Receive Rights
Option 1: Exercise Your Rights
Pay the subscription price to receive the new shares. This makes sense when you believe in the company and want to maintain or increase your ownership at a discounted price.
Example: Exercising Rights
Stock trades at $50. You receive rights to buy shares at $40 (a 20% discount). You exercise your rights by paying $40 per share. If the stock stays at $50, you immediately have a $10 per share gain on the new shares.
Option 2: Sell Your Rights
Many rights are tradeable on the open market. If you do not want to invest more money, you can sell your rights to recover some value and avoid dilution.
Example: Selling Rights
The rights to buy shares at $40 when the stock trades at $50 have intrinsic value of approximately $10 per right (depending on ratio and time value). You can sell your rights on the market and receive cash without investing additional capital.
Option 3: Do Nothing (Usually a Bad Idea)
If you let your rights expire unexercised and unsold, you lose their value and experience dilution. Your ownership percentage decreases, and you receive nothing in return.
Important: Never let rights expire worthless. Even if you do not want to exercise them, sell them on the market or back to the company if an over-subscription option exists.
Trading Strategies for Rights Offerings
Strategy 1: Arbitrage the Rights
If rights are trading below their theoretical value, buy the rights and exercise them to acquire shares at below-market prices. This works when the market is not efficiently pricing the rights.
Strategy 2: Buy Shares Cum-Rights
Purchase shares before the ex-rights date to receive the rights attached. This can be profitable if the combined value of shares plus rights exceeds the purchase price.
Strategy 3: Oversubscription Participation
Many rights offerings allow shareholders to subscribe for additional shares beyond their basic entitlement if others do not exercise their rights. This can be a way to acquire more discounted shares.
Strategy 4: Short-Term Rights Trading
Trade the rights themselves as they fluctuate in value based on the underlying stock price and time remaining until expiration. This is similar to trading options.
Calculating Rights Value
The theoretical value of a right can be calculated using this formula:
- Cum-Rights Value: (Stock Price - Subscription Price) / (Number of Rights Needed + 1)
- Ex-Rights Value: (Stock Price - Subscription Price) / Number of Rights Needed
Example Calculation
Stock price: $50, Subscription price: $40, Rights ratio: 5 rights needed to buy 1 share
Theoretical value (ex-rights): ($50 - $40) / 5 = $2 per right
If rights are trading at $1.50, they may be undervalued and worth buying.
Red Flags in Rights Offerings
- Desperate capital raise: If the company is struggling and needs cash urgently, the stock may continue to decline
- Large discount: An unusually large discount suggests the company could not raise money at better prices
- Frequent rights offerings: Multiple capital raises may indicate ongoing financial problems
- Insiders not participating: If management is not exercising their rights, that is concerning
- Short subscription period: A very short window may pressure shareholders into quick decisions
Tax Considerations
The tax treatment of rights depends on your actions:
- Exercising rights: No immediate tax impact. Your cost basis in the new shares equals the subscription price.
- Selling rights: The proceeds are typically treated as short-term capital gains if the rights were held for less than a year.
- Rights expiring worthless: You may be able to claim a capital loss.
Track Your Rights Offering Trades
Pro Trader Dashboard helps you track complex corporate actions including rights offerings. Monitor your positions, track cost basis, and analyze your returns.
Summary
Rights offerings give existing shareholders valuable opportunities to buy additional shares at discounted prices. The key is understanding your options: exercise the rights to acquire discounted shares, sell the rights to receive cash, or participate in oversubscription. Never let rights expire worthless. Before making a decision, evaluate why the company is raising capital and whether the investment makes sense for your portfolio.
Want to learn about other capital return events? Read about special dividends or explore stock buyback strategies.