Warrants

Warrants, like options, give the holder the right but not the obligation to buy an underlying security (typically a specific number of shares) at a certain price, quantity and future time.

However, unlike an option, a stock-exchange product, a warrant is issued by a company. The shares are delivered by the issuing company instead of an investor holding the shares.

There are two different types, a call warrant and a put warrant. A call warrant represents a specific number of shares that can be purchased from the issuer at a specific price, on or before a certain date.

A put warrant represents a certain amount of equity that can be sold back to the issuer at a specified price, on or before a stated date.

All warrants have a specified expiry date. An American warrant can be exercised anytime before or on the stated expiry date. A European warrant, on the other hand, can be carried out only on the day of expiration.

The exercise price or strike price is the amount that must be paid in order to either buy the call warrant or sell the put warrant. The payment of the strike price results in a transfer of the specified amount of stock.

The conversion ratio is the number of warrants needed in order to buy (or sell) one share. If the conversion ratio to buy stock ABC is 4:1, this means that the holder needs four warrants in order to purchase one share.

Usually, if the conversion ratio is high, the price of the share will be low, and vice versa.

Warrants are transferable and they tend to be more attractive for medium-term to long-term investment plans. They are high risk, high return investment tools. Warrants are also an attractive option for speculators and hedgers.

Transparency is high and warrants offer a viable option for private investors as well. This is because the cost of a warrant is commonly low, and the initial investment needed to command a large amount of equity is quite small.

As an example of one of the potential benefits of warrants, say that ABC shares are currently priced on the market for $1.50 per share. In order to purchase 1,000 shares, an investor would need $1,500.

However, if the investor opted to buy a warrant (representing one share) that was going for $0.50 per warrant, with the same $1,500, s/he would possess 3,000 shares instead.

Because the prices of warrants are low, the leverage and gearing they offer is high. This means that there is a potential for larger capital gains and losses.

A disadvantage and risk to the warrant investor is that the value of the certificate can drop to zero. If that were to happen before it is exercised, the warrant would lose any redemption value.

Also, a holder of a warrant does not have any voting, shareholding or dividend rights. The investor can therefore have no say in the functioning of the company, even though s/he is affected by any decisions made.

Investors in Australia can include warrants in do-it-yourself superannuation portfolios in order to gear the portfolio. For some reason which defies logic they are not permitted to use margin loans for the same purpose.

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