Warrants

What are warrants?

A warrant is a type of derivative that gives an investor the right, but not the obligation, to buy the underlying security in specific time windows and at a given price. Warrants are issued by companies and can sometimes be traded on the stock market.

When a warrant is exercised, the investor gets a newly issued investment, such as shares, which are the most common and what we’ll focus on.

A warrant is therefore classified as a dilutive, increasing the number of shares in issue.

How do warrants work?

Warrants give the holder the right to buy shares in the issuing company at a set price and at a future date. They’re not issued by individuals or the market itself.

Warrants will have a price you have to pay to convert it into an ordinary share. This is called the exercise price. And, by converting warrants into ordinary shares, the investor is exercising the warrants. Usually, one warrant equals one ordinary share, however, there are some exceptions where several warrants equal one ordinary share.

Warrants usually come with one or more exercise dates which are the dates investors can turn their warrants into shares. These are usually fixed dates in each year (for example 1 June and 1 December). In most cases, warrants have a final exercise date which is the last date the warrants can be exercised. After this date the warrants are cancelled. However, if you fail to exercise them you could still get a cash payment, but only if the warrants have a value on this date. There is a risk your warrants become worthless.

Exercising a warrant will sometimes cost more than buying the ordinary shares in the stock market. This is because the warrant’s price to convert to ordinary shares is fixed, but the market value of the ordinary shares will still move. Companies could give warrants to current shareholders in a corporate action, with an exercise price which is higher than the current market price.

Warrants can usually be traded in the market, meaning you can sell your warrants as an alternative to exercising them.

Warrant vs Options

Warrants and Options are similar but not the same.

Standard warrants, issued by the company, give the right, not an obligation, to buy their company’s stock at a specified time and date. These shares are issued by the company and increase the number of shares in issue.

Options instead form a contract between two parties that gives the holder the right, but not the obligation, to buy or sell a stock at a specific price before a specific date. They are generally not issued by the company and when an option is completed, the stock transfers between the two parties.

Warrants can also be traded on a stock exchange – those that do will have ISIN codes and a price that updates daily. The warrant itself has a fixed price for the underlying company’s shares, but the price of buying the warrant through the exchange will update like a share would.

The other main difference is length of term attached to them. Warrants are typically measured in years while options are usually shorter term.

However, they are similar with both having an exercise price, an expiration date and having no obligation to exercise. With both and all types of investment you could make a loss.

Why do companies issue warrants?

Companies can issue warrants for a couple of reasons.

Firstly, raising capital. Offering the opportunity to buy shares in the company at a potential discount to the current market value can attract budding investors.

Secondly, companies could be trying to reward existing shareholders if the company does well in the future and the share price rises above the exercise price by the exercise date. This way, you can have the option to buy additional shares but below market price, increasing the capital that the company will have but also offering a guaranteed method of buying the shares at a fixed price.

Are warrants good or bad for investors?

Warrants don’t offer the same privileges as holding the ordinary shares. While you can exercise them to buy the shares, warrant holders can’t take part in AGMs, vote on any corporate actions or receive dividends.

You’re also at the mercy of the market and the company’s share price moving. If you hold the warrant for a fixed price and the demand drops causing the share price to fall, your warrant will cost more to exercise than buying the shares separately.

If the share price dramatically rises, and the fixed price is cheaper than the current market price, your warrants will let you exercise them, buying the stock at a cheaper rate.

Warrants also offer flexibility in when you want to invest in a company. If an investor held the warrants but was hesitant at the upcoming financial results for that company, they could hold off for a later point before exercising them. As warrants have typically longer expiration periods than options, investors can choose the time that suits them best over a longer period, depending on the exercise dates available. As it offers a fixed price, it guarantees the investor’s cost as opposed to when buying through the market where quotes can be above or below market value.

As with all investments, their value can fall as well as rise so you could get back less than you invest.