Stock Warrants are the options that give investors the right to buy a company’s stock at a specific price until the expiration date. The company itself issues these options and gives investors the right (but not obligation) to buy the stock. This means an investor is free to decide if he wants to buy the underlying security or not. Thus, a warrant does not give the holder the ownership of the stock but rather the right to buy the stock in the future.
Stock warrants are mostly given along with the bond. When a company issues a bond, it attaches a warrant along to make it more attractive to the investors. So, warrants are a bonus for bond investors.
- A company issues new shares to honor the warrants, leading to a rise in the total outstanding shares.
- The ‘exercise price’ or the price at which the investors can buy the shares, is fixed after the bond is issued.
- No voting or dividend
- Not usually listed on stock exchanges.
How are they Useful to the Issuer?
Usually, the underlying stock in the warrant is the common stock of the issuer. When holders exercise the option, they get the newly issued shares. So, it helps to increase the company’s capital. Therefore, they are a good option for start-ups, which can attach warrants to make their bonds and shares more attractive.
Stock warrants are also a good capitalization option when a company is nearing bankruptcy. By issuing warrants, the company secures a future source of capital. It is easier to convince an investor to buy a warrant for $10 than to purchase more shares at $100.
How are they Useful to the Investor?
For investors, it is also an attractive option. They see it as a reward for investing in a company. A holder usually exercises the option when the issuer’s stock price goes above the warrant price. This allows the investor to buy the shares at a lower price by exercising the warrant.
For example, Company A issues bonds with warrants attached. The holder gets bonds with $500 face value and the right to buy 50 shares at $10 each within five years. In this case, the holder can buy the shares at $10 even if the market value is above that. After five years, if an investor does not use the warrant, it becomes worthless.
Investors can also trade a warrant. The value of a warrant is the difference between the current value of the underlying stock and the strike price. This difference is the profit a holder will get if they exercise the warrant now. Investors can trade warrants for a premium as well if the trader believes the price of the underlying security to go up in the future. The premium reduces as the expiration date approaches.
Trading warrants, however, can be difficult and time-consuming as they are usually not listed on the exchanges.
Types of Stock Warrants
A company usually issues two types of warrants – a call warrant and a put warrant. A call warrant represents the right to buy a certain number of stocks from a company at a specific price in the future. On the other hand, a put warrant represents the amount of stock that is sold to the issuer at a certain price in the future.
Stock warrants can also be Detachable and Non-Detachable. Holders of the detachable warrants can sell the warrant without selling the bond or stock they were originally attached with. Holders of non-detachable warrants can only sell them along with the bond or stock they came with.
How it’s Different from a Stock Option?
A stock option is very similar to a stock warrant. It is an agreement between two parties that give holders the right (not obligation) to buy or sell the stocks at a certain price and a specific date. But it is different from the warrant in two ways – the company does not issue the stock option, and the company does not issue new shares when a holder exercises the option.
If a holder exercises the option, then the shares move from one investor to another. But, in case of a warrant, the company issues new shares for the holders. So, the stock warrants help the company raise capital. On the other hand, the company does not get any money when the stock options are purchased or sold.
Also, a warrant is usually offered at a price lower than the stock option. Moreover, the maximum duration of the option is two to three years, but a warrant can stretch up to fifteen years. Unlike the stock options traded on the public exchanges, the warrants are usually traded over the counter.
Stock options are usually given to the employees, while warrants are given to attract investors. Also, both get different tax treatment. Since a warrant is not compensatory, it is better for tax purposes. Overall, it won’t be wrong to say that stock warrants are a better investment option when considering mid-to-long-term investments.