What Is a Warrant?
Warrants are aderivative that give the right, but not the obligation, to buy or sell a security—most commonlyanequity—at a certain price before expiration. The price at which the underlying security can be bought or sold is referred to as the exercise price or strike price. An American warrant can be exercised at any time on or before the expiration date, while European warrants can only be exercised on the expiration date. Warrants that give the right to buy a security are known as call warrants; those that give the right to sell a security are known as put warrants.
Key Takeaways
- Naked warrants are issued on their own, without accompanying bonds or preferred stock.
- There are a variety of warrants such as traditional, naked, wedded, and covered.
- Investors may find trading warrants to be a complex endeavor.
How a Warrant Works
Warrants are in many ways similar to options, but a few key differences distinguish them. Warrants are generally issued by the company itself, not a third party, and they are traded over-the-counter more often than on an exchange. Investors cannot write warrants like they can options.
Unlike options, warrants are dilutive. When an investor exercises theirwarrant, they receivenewly issued stock, rather than already-outstanding stock. Warrants tend to have much longer periods between issue and expiration than options, of years rather than months.
Warrants do not pay dividends or come with voting rights. Investors are attracted to warrants as a means of leveraging their positions in a security, hedging against downside risk (for example, by combining a put warrant with a long positionin the underlying stock), or exploiting arbitrage opportunities.
Warrants are no longercommon in the United States but are heavily traded in Hong Kong, Germany, and other countries.
Types Of Warrants
Traditional warrants are issued in conjunction with bonds,which in turn are calledwarrant-linked bonds, as a sweetener that allows the issuer to offer a lower coupon rate. These warrants are often detachable, meaning that they can be separated from the bond and sold on the secondary markets before expiration. A detachable warrant can also be issued in conjunction with preferred stock.
Wedded or wedding warrants are not detachable, and the investor must surrender the bond or preferred stock the warrant is "wedded" to in order to exercise it.
Covered warrants are issued by financial institutions rather than companies, so no new stock is issued when covered warrants are exercised. Rather, the warrants are "covered" in that the issuing institution already owns the underlying shares or can somehow acquire them. The underlying securities are not limited to equity, as with other types of warrants, but may be currencies, commodities, or any number of other financial instruments.
How to Find Derivative Warrants
Trading and finding information on warrants can be difficult and time-consumingas most warrants are notlisted on major exchanges, and data on warrant issues is not readily available for free.
When a warrant is listed on an exchange, its ticker symbol will often be the symbol of the company's common stock with a W added to the end. For example,Abeona Therapeutics Inc's (ABEO) warrants were listed on Nasdaq under the symbol ABEOW. In other cases, a Z will be added, or a letter denoting the specific issue (A, B, C…).
Warrants generally trade at a premium, which is subject to time decay as the expiration date nears.As with options, warrants can be priced using the Black Scholes model.
How do derivative warrants differ from options?
Both derivative warrants and options give the holder the right to buy or sell shares at a set price before a specified date. However, options are listed on an exchange and traded from investor to investor while derivative warrants are issued by the company itself.
What does it mean for a derivative warrant to be dilutive?
A derivative warrant is dilutive because it dilutes or reduces each other shareholder's ownership in the issuing company. If you hold a warrant allowing you to buy 1 share in a company that currently has 10 shares outstanding and you exercise it, the number of shares outstanding will increase to 11. You'll gain ownership while each other shareholder will lose a percentage of their stake in the company.
What happens if a derivative warrant expires?
If a warrant expires without being exercised, it becomes worthless. The holder of that warrant can no longer use it to buy shares in the issuing company.
Why buy derivative warrants over options?
Derivative warrants have some advantages over options. For example, they have much longer expiration timelines and are often attached to otherwise already valuable securities, such as bonds.
The Bottom Line
Derivative warrants are a complex type of security that isn't widely traded. They give investors the opportunity to buy shares in a company, but can be difficult to research and costs for trading can be high.
