Stock warrants are highly complex derivatives that allow the investor to buy the stock through Warrant Call or sell the stock through a warrant put at a date specified in the contract at a fixed price.
The stock warrants are like options contracts, but there are two major differences between warrant contracts and options contracts. One is that the company issues warrants instead of a third party like a bank. As a result, their market is tiny. The second major difference between the stock warrants and options is that the warrant is traded over the counter or OTC. It means that they are not traded on the stock market.
The stock warrants also have a very long expiry date as compared to the options contracts. This is because the warrants are worthless after they expire. A warrants contract also allows an investor to buy or sell the stock within any time covered under the contract.
How does it work?
Take an example of a company that issues stock warrants to investors at an expiry date of five years. Unfortunately, the numbers of investors are small, and as a result, there is not much of a demand for warrant contracts.
One half buys a put warrants contract, and the other half buys a call warrants contract. The company limits the number of issues. Half of the investors believe that the stock price would fall, while the other half believe that the price would increase. Within five years, any of the investors can buy or sell the underlying stock.
Features of Stock Warrants
The main features of stock warrants are as follows:
i) Warrants are issued by a company instead of a third party like a bank.
ii) They are highly complex derivatives that carry a high risk, high reward proposition.
iii) There is a very high risk that the company that issued the warrants could go bankrupt, which would leave the investors holding the bag.
iv) The expiry time for these types of contracts is unusually long. The warrants can have an expiry date of more than five years.
v) As Warrants are traded over the counter, there is a high risk of fraud compared to the options contracts.
There are four main types of stock warrants. All four of them are shown in figure 1 below:
Four Types of Warrants
The four main types of stock warrants are American Style, European Style, Call warrant, and put warrant. All four of these are classified on a different basis, and the detail of each is provided below:
American style Stock Warrants
American style warrant contracts are classified based on their ability to be used at any date specified in the contract. It means that American Style Stock Warrants can be used at any date before the expiry date of the warranty contract.
They can be used a day after, a month after, a year after, and even on the expiry date, as long as they are used within the expiry date. After the warrant contract expires, it becomes useless. While many investors hold on to the warrants for a long time and usually use them just a bit before the expiry date, it does give an investor an advantage to use their contract at any time.
European style Stock Warrants
The European-style stock warrant is the opposite of the American-style stock warrant. It can only be exercised on the day of the expiry. The investors cannot exercise it before the day of the expiry.
One of the greatest advantages of these types of stock warrants is that it provides a stable situation while also helping the company avoid any speculation that may result in the company going bankrupt. But, it also means that an investor has no way of getting his/ her money out before the expiry date.
Call Stock Warrant
Call Stock Warrant is similar to call options contract. The main difference is that the company issues a call stock warrant. The call stock warrant allows the holder to buy the company’s stock at the current price in the future. There is no obligation to buy the stock as the call option, and investors can let the warrant expire if they want to.
The European Call stock warrants can only be exercised on the expiry day, whereas the American Style call stock warrant can be exercised at any date before the expiry date.
Put Stock Warrant
The put stock warrant, like the call stock warrant, is similar to the put options contract. The major differences are that they are issued by the company and traded over the counter. The put stock warrant allows the investors to sell the stock at a specified price in the future at or before the expiry date. It also does not oblige an investor to sell the stock, but the warrant would become useless after the expiry date.
The same rule applies to the Put stock warrant as to the call stock warrants for the European and American Styles.
Main Benefits of the stock warrants
There are numerous advantages of stock warrants. The main benefits are listed as follows:
i) The profits are unbelievably high for the stock warrants. There are limited numbers issued every year, so there is a high demand for Stock Warrants.
ii) The Stock warrants have a very long expiry date.
iii) The investors are also allowed to collect dividends on the stock they are holding. This allows offsetting the payment of premiums on the Stocks Warrants.
The stock warrants are similar to option contracts, but they are riskier and carry a higher profit potential. Stock warrants are a liable long-term investment strategy, but they are also very complex financial products, so investors must truly understand warrants before investing in them.