When it comes to trading stocks with convertible securities or warrants, dilution is often misunderstood. While dilution can certainly affect a stock’s long-term value, in the short term, it’s usually the timing and nature of specific catalysts—not the dilution itself—that drive sharp price movements.
Where to Find Adjustment Clauses
One key area to focus on is whether a conversion price or warrant exercise price can be adjusted. This information is typically buried in the exhibits of a filing—specifically those related to convertible notes or warrants. Sometimes, you'll find summary details posted in Discord research channels or internal notes, but the real value lies in going directly to the source filings.
To locate these clauses:
- Open the relevant filing (often an 8-K or 6-K).
- Look for exhibits labeled Convertible Note Purchase Agreement or Warrant Agreement (usually EX 4.1 or 4.2).
- Search for language around "adjustment events," "share combinations," or "reset clauses." (Or simply use the AI chat)
These are the fine-print sections where companies spell out the exact conditions under which prices can be lowered.
A Real Example: Reverse Split Triggers Adjustment
In a recent case we tracked, a company had just completed a reverse stock split. One of the clauses in the convertible note stated that if a share combination event (like a reverse split) occurs, the conversion price would reset to the average of the five lowest VWAPs in the 16 days following the split.
The original conversion price looked “out of play” at $6.05, but after the adjustment clause was triggered, it dropped to around $2.50. And that wasn’t the end of it. Another clause allowed the conversion price to reset again when the registration statement becomes effective—a pending event at the time.
Why This Matters More Than the Dilution Itself
Here’s the key: these events act as catalysts, and they’re often more influential than the actual dilution that follows.
When a reset is expected, the holders of the convertible note (or warrants) are often incentivized to short the stock ahead of the adjustment. The lower the stock goes, the more favorable their conversion terms become. This selling pressure—driven by the mechanics of the deal—can create significant downward momentum, completely independent of any actual new share issuance.
Same Logic Applies to Warrants
The same principles apply to warrant inducement deals. If a company has a history of doing inducements, needs to raise cash, and has expiring or out-of-the-money warrants, traders can often anticipate a potential reset or offering. In these situations, it’s not just the dilution risk that matters—it's the incentive for warrant holders to short ahead of the announcement.
Conclusion
In setups like these, it’s rarely the dilution alone that causes a sell-off. It’s the catalyst—the specific event that changes the terms and tilts the playing field in favor of the security holder. Recognizing these moments and knowing where to look for them in SEC filings is crucial for navigating volatile small-cap names.
🎥 Watch the Video Breakdown
For a full walkthrough of this setup and how to spot these adjustment clauses in SEC filings, check out the video here:
👉 https://youtu.be/4A6w9RC4poE