Warrants – A Beginner’s Guide

The Basics of Warrants

The history of derivative investments goes back thousands of years when financial contracts whose value relied on, or “derived from”  an underlying asset came into being. In the early days, the underlying assets were most often agricultural commodities with a contract setting a future time and price for purchase.

In today’s complex investing environment, there are a variety of derivative investments from which to choose, among them are warrants.

What Are Warrants

Warrants are derivative contracts giving the warrant purchaser the right, but not the obligation, to buy or sell the underlying asset at a set price prior to expiration of the contract. Stocks are by far the most commonly used underlying asset in warrant contracts.

Warrants are similar to stock options with the key difference found in the parties to the contract. In Options trading, the contract is traded between investors while warrants are issued directly by the company issuing the stock, or by a financial institution..

When stock warrants issued by a company are exercised, the stock does not come from shares outstanding, but from the company issuing new shares. Creating new shares has the effect of diluting the value of existing shareholders and when issued typically drives down the stock price due to the dilution. The price agreed is called the exercise or strike price.

In the US, the warrant can be struck at any time prior to the expiration date specified in the contract. Warrants in Europe must be struck on the expiration date.

Types of Warrants

There are two basic types of warrants – a Call Warrant and a Put Warrant. Call Warrants grant the warrant purchaser the right to buy the underlying stock while Put Warrants give the purchaser the right to sell the stock. The purchaser is under no obligation to buy or sell the stock.

Call and Put warrants are the most common types, but there are others, including Covered Warrants and Naked Warrants.

Covered Warrants are not issued by a company but by a financial institution, with the same parameters as Call and Put Warrants. The stock  or other asset involved comes from the holdings of the financial institution issuing the warrant, not from new stock issued by the company.

Regardless of issuer, purchasers of warrants believing a stock’s price will rise opt for Call Warrants while purchasers expecting the stock price to drop will opt for Put Warrants.

Unlike the short-term nature of options contracts, warrants have long-term expiration dates, stretching out as far as fifteen years.

There are complex variations with warrants, like the Naked Warrant, not backed by an underlying asset. Warrants are declining in popularity in the United States but remain common in other global markets, like China, Hong Kong, Germany, Canada, Australia, and other countries.

Installment Warrants here in Australia are issued by banks and other financial institutions from their stock holdings allowing the purchaser to pay for the warrant over time. Installment warrants are tradeable on the ASX, with the initial installment generally set at 50% of the price of the underlying asset.

Warrants vs Options vs Futures

Warrants, Options, and Futures are all examples of derivatives, with their value determined by the asset underlying the derivative contract – stocks, bonds, or commodities.

Investors gravitate towards derivatives for two main reasons – as a hedge to minimize risk and as speculation on the asset’s profit potential.

All three are cemented by contractual arrangements between two parties, but the parties differ.

Warrants are contracts between a purchaser and either the company owning the underlying asset or a financial institution with access to the underlying asset.

Options are contracts between two individual investors specifying a buy or sale price that can be “struck” or exercised within a specific time period. Call options for buying stocks are the most common, exercised only if the market price at the time of the strike is greater than the price in the options contract.

Put options are exercised if the market price of the stock at the time of the strike is lower than the price in the options contract.

Futures contracts were the first use of derivatives centuries ago when agricultural producers and users of the agricultural products struck an agreement to buy or sell the products at a specified price and a specified time. Unlike warrants and options, futures contracts require a settlement at the time the contract expires, which can be accomplished in multiple ways.

In the dawn of futures contracts both participants were seeking to “hedge” their position in acceptable ways. A farmer agreed to sell his harvest at a fair price in the future, protecting him from unforeseen drops in market prices. The buyer agrees to that fair price for the same reason – to protect against unforeseen price movements in the commodity.

Speculators entered the market with the intent of selling the futures contract at a profit prior to expiration should the market price move in their favor.

The similarities between the three derivative instruments are the specified price and the specified time frame. The major difference is the obligation to execute the futures contract. Options and warrants can expire without execution. With futures contracts, cash settlements can be made in lieu of taking physical delivery of the commodity.

The Pros and Cons of Warrants

The major advantage of stock warrants is the ability to control significant amount of stocks at low cost. With a relatively small capital expenditure up front, an investor can access stocks for a fraction of the market price.

However, the corresponding con is the time sensitivity of the warrant. If the price of the stock is lower than the price in the warrant contract, the investor will lose the investment as the warrant expires without execution.

When warrants are issued by a dividend paying company, the strike price can go down due to dividend payments during the period, to the benefit of the purchaser.

The length of the expiration period benefits purchasers from the potential of long-term price changes in the stock.

Perhaps the major cons to warrants are their availability and complexity. Market experts advise potential warrant shoppers to make use of financial advisors in their search and decision making.

A stock warrant is a financial instrument allowing the purchaser to buy or sell a set quantity of shares in the issuing company at a set price within a set time frame, with no obligation to execute the warrant. Warrants are one of three derivative financial tools available to investors, along with options and futures contracts.

Don’t Buy Just Yet

You will want to see this before you make any decisions.

Before you decide which shares to add to your portfolio you might want to take a look at this special report we recently published.

Our experts picked out The 5 best ASX shares to buy in 2025.

We’re giving away this valuable research for FREE.

Click below to secure your copy