A stock warrant allows investors to buy or sell shares at a set price and date. This contract is similar to options, although certain characteristics separate warrants from option contracts.
Let’s further look into what stock warrants are all about.
Stock Warrants Explained
A stock warrant is another type of derivative contract between publicly traded companies (the issuers) and investors (the warrant holders).
With warrants, holders are granted buying or selling rights to a company’s shares at a particular price before the set date. Like option holders, warrant holders are not obligated to purchase or put the underlying stock on sale.
Additionally, warrants have a strike price or the specific price at which holders can buy or sell the underlying stock. They also have a maturity date of one to two years, or sometimes, more than five years. Once the warrant expires, the holder would no longer have use of it.
One stock warrant is usually equivalent to one share, meaning you can only buy or sell a single share with a single warrant.
Once the warrants have been exercised to purchase a stock, the company will issue new shares instead of outstanding stock. However, the new shares are dilutive, reducing the interest of the existing shareholders.
The company can provide you with the shares directly once the warrant is exercised. Although, if you have a warrant through an online broker, you can hold it in a standard account. You can buy or sell them the same way you do with stocks.
Call and Put Warrants
Warrants are classified into two types: Call warrants and put warrants.
Call Warrants
Call warrants, which most warrants are, give holders the right, but not the obligation, to buy shares at a set strike price in a specific period that is on or before the warrant’s expiration date.
It is recommended to only exercise a call warrant when the stock’s market price is higher than the exercise price, i.e., in-the-money (ITM).
Put Warrants
Put warrants allow, but not obligate, the holder to sell a particular number of shares to the issuing company at the strike price. This type of warrant is exercised at the strike price and is only considered ITM when the market price is lower than the strike price.
Other Important Aspects of Stock Warrants
Note that stock warrants are classified based on how they are exercised. US warrants can be exercised at any time on or before their expiration date. On the other hand, European warrants can only be exercised on their expiration date.
You also need to remember that warrants have a conversion ratio representing the number of warrants required to buy or sell one share. Let’s say a call warrant has a conversion ratio of 3:1. To purchase one share, you will need three warrants.
Reasons for a Company to Issue Stock Warrants
Increase Funding
Companies often sell or resell stock warrants in the open market or financial institutions to raise their capital. Once the warrants are exercised, the company’s funding receives a boost through the sale of the warrants and the stock.
To Acquire Another Business
Similar to the reason above, companies may add stock warrants to back their acquisition of another business or company. They may also use warrants to seal strategic ties or deals to encourage other parties to join the arrangement or invest in the business’s long-term success.
Make Bonds or Preferred Stocks More Appealing
Stock warrants can also be used as sweeteners to bonds or preferred stocks, which help raise their value in the markets, making them more appealing to buyers.
A bond with a warrant can allow buyers to take advantage of soaring share prices by exercising their warrants when share values hit ideal conversion levels.
