What Are Stock Warrants?
A warrant gives its holder the right to buy stock shares at a fixed price
Stocks warrants may sound like a legal process for arresting something or someone—your stockbroker, maybe? They're not nearly that exciting, but they can make you some money, at least when you handle them right.
Definition of a Stock Warrant
In its most basic form, a stock warrant is simply the right to purchase shares of a stock at a certain price. Warrants are good for a fixed period of time, and they're worthless once they expire. You're not locked in when you buy a warrant. You're always free to decide that you don't want to buy the underlying security.
A put warrant sets a certain amount of equity that can be sold back to the company at a given price. A call warrant guarantees your right to purchase a set number of shares at a certain price.
Stock Warrants vs. Stock Options
In many ways, a stock warrant is like a stock option. A stock option also gives the holder the right to buy shares at a fixed price during a defined period of time. But there are a few major differences. One is that warrants are often good for a number of years, as many as 15 in some cases. Options typically expire in less than a year, although some can extend for two or three years.
Another difference between options and warrants is how they originate. Options are offered by the stock exchange, whereas warrants are normally only issued by the company whose stock is subject to the warrant. The most frequent way warrants are used is in conjunction with a bond.
A company issues a bond and attaches a warrant to the bond to make it more attractive to investors. If the issuer's stock increases in price above the warrant's stated price, the investor can redeem the warrant and buy the shares at the lower price. For example, if the warrant has a strike price of $20 per share and the market price of the stock rises to $25 per share, the investor can redeem the warrant and buy the shares for $20 per share.
If the stock never rises above the strike price, the warrant expires, so it becomes worthless. There are complicated formulas for determining the value of warrants based on the strike price, the current market price, the time until expiration, and other factors.
The Bottom Line
This explanation describes how a simple warrant works, but the matter isn't quite that simple in reality. Different types of warrants have varying degrees of risk and value. Be sure you completely understand the terms and conditions of any warrant before you become involved in these securities. A number of other third-party options out there can achieve the same result...although you'd have to do your homework to explore and understand those as well.
Note: Always consult with a financial professional for the most up-to-date information and trends. This article is not investment advice and it is not intended as investment advice.