What is a Warrant? - 2022 - Robinhood (2024)

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A call warrant is like leasing a car before buying it…

Do you like how it performs? Do you want to commit? The upfront investment is relatively low risk. If you want to buy, you have the option to do so at the specific strike price for a period of time.

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A warrant is a financial product that companies issue to investors that gives the investor the right to either buy or sell the company’s stock at a specific price before the warrant’s expiration date.

A warrant is a type of derivative, meaning it is a contractual agreement between two parties, and it derives its value from the performance of an underlying asset (in this case, the company’s stock).

A call warrant allows the investor to buy stock from the company at a specific price before the expiration date. A call warrant can be profitable if the warrant allows them to buy stock for less than they can buy it in the stock market.

A put warrant allows the investor to sell stock back to the company at a particular price. A put warrant can be profitable if it enables the investor to sell the stock to the company for more than the price they’d be able to sell it for in the stock market.

If a warrant reaches its expiration date without being in the money (aka profitable), the investor likely won’t exercise the warrant.

For example, let’s say an investor purchases a call warrant from a company — The warrant allows them to buy the company’s stock at $20 per share, up until a set date. Suppose that over the life of the warrant, the stock price never exceeds $15. The investor would likely let this warrant expire without exercising it.

It wouldn’t make sense for them to use the warrant to purchase stock at $20 per share when they could buy it through the stock market at $15 per share. If the investor allows the warrant to expire without exercising it, their only loss is the money they spent on the warrant. Warrants can also be bought and sold on the secondary market or exchange up until expiration.

Warrants come in a few different forms. The first is a naked warrant — This is the most basic type of warrant a company might sell. It’s not attached to a bond. Instead, the investor purchases the warrant and has the right to buy or sell the underlying stock.

A traditional warrant is one that comes with the purchase of a bond. Companies sell these bonds to investors at a lower interest rate than they would without the warrant. Then, the investor can either exercise or sell the warrant before the expiration date. This type of warrant is also called a detachable warrant because the investor can detach the warrant from the original security.

Another type of warrant is a wedding warrant (also known as a harmless warrant). A wedding warrant is a provision attached to a bond that requires the investor to relinquish the bond if they purchase another with similar features from the same company. The purpose of a wedding bond from the perspective of the company is that it allows them to maintain a particular level of debt — They don’t have to issue new debt to sell a new bond to an investor.

Finally, a covered warrant is one that a financial institution issues instead of a particular company. The financial institution will purchase the underlying security and then sell the warrant to an investor.

Some companies sell bonds with call warrants attached to them. If you purchase one of these products, you have the benefit of owning the bond, as well as having the potential to buy the company’s stock at a higher price down the road.

Bonds with warrants give the investors the potential to diversify their portfolio. But these bonds aren’t without their downsides. Bonds with warrants attached tend to have lower interest rates than traditional bonds since they offer additional earning potential to the investor.

In many ways, warrants and options are the same. They both give the owner the right to buy and sell an underlying stock at a specific price before the expiration date (aka expiry date).

The primary difference between the two products comes down to the parties involved. In the case of an option, the two participating parties are usually both investors — One investor is selling the option to another.

Suppose that one party sells a call option to another. The investor buying the call option has the right to buy the underlying stock from the seller for a predetermined strike price before the expiration date. Assuming the buyer would like to exercise the contract, the buyer makes money on the call option if the underlying stock’s price increases past their breakeven amount. They get to buy the stock for less than it’s currently trading for. Then they can turn around and sell it at full price, which gives them a profit not taking into account any possible fees, taxes, or commission involved.

In the case of warrants, one party is an investor, and the other party (the one selling the warrant) is the company whose stock the warrant represents. But in many other ways, the products work nearly the same.

For a call warrant, the buyer has the right to buy the underlying stock for a particular price before the expiration, just as they would with a call option. The difference is that instead of buying the stock from another investor, they are buying shares directly from the issuing company.

Warrants and options also differ considerably in terms of the expiration date. A company might sell a stock warrant with an expiration date that is up to 15 years away. Options, on the other hand, expire either in three, six, nine months, 1 year, or 3 years.

The other difference between warrants and options is the impact they have on the number of shares of stock available. When an investor sells an option, the company has already issued the underlying stock. When a company issues a warrant, and the buyer exercises it, the company typically issues new shares to that investor. Therefore, issuing warrants can dilute ownership for other shareholders.

A company might issue warrants to entice more investors to purchase their stocks and bonds. First, the company makes money by selling the warrants. They also lock in future income for their company, since usually some investors will act on the warrant before the expiration date, as long as the price is right.

A company might choose to issue warrants if they’re going to be raising capital for future projects or if they’re struggling financially and will need the revenue boost later on.

Imagine that a company is selling stocks at $200 per share. They’re struggling to find as many investors as they need to fund their next capital project. Instead, they begin selling warrants for $20.

An investor might be more inclined to purchase a $20 call warrant than buying shares at $200. And, if the stock's price rises above the strike price on the warrants, the company could have an influx of investors exercising their right to purchase shares below market value.

Companies in the United States don’t frequently use warrants — They are far more prevalent in other countries, such as China.

Whether or not warrants are the right choice for you depends on your appetite for risk. Warrants tend to be a high risk, high reward investment.

If you’re able to exercise your warrant for a profit, you would likely call them ‘good’. On the other hand, there’s a risk of a warrant expiring without being in the money. In this case, you’ll lose the money you spent on the warrant and don’t have any stock to show for it.

Another disadvantage of stock warrants is that they don’t give you the voting rights that shareholders have or dividend rights, until or unless you exercise it and own the stock. When you purchase a stock warrant, you’ve already given the company some of your money, and their decisions can financially affect you. But you don’t have the same voice you’d have if you had bought stock.

Purchasing stock warrants might be a bit trickier than purchasing stock shares since companies don’t always list them on major exchanges as they would with stocks.

Warrants that are available on an exchange typically have the same ticker symbol as the company’s stock with the letter “W” added to the end of it.

As with other securities, let your broker know what you’re looking for, and they can likely track it down for you.

All investment carries risk. Always keep your investment objectives in mind.

Options trading entails significant risk and is not appropriate for all investors. Customers must read and understand the Characteristics and Risks of Standardized Options before engaging in any options trading strategies. Customers should consider their investment objectives and risks carefully before investing in options. Supporting documentation for any claims, if applicable, will be furnished upon request.

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