Types of warrants: call warrant and put warrant, European vs American warrants

In the stock market, various types of financial instruments, like warrants, are traded. Warrants are financial instruments quite similar to options, but there are key differences between the two types of derivatives.

Let's explore different types of warrants and other essential aspects.

warrants finance

Warrants give the holder the right, but not the obligation, to buy or sell shares at a fixed price within a set period. A warrant is essentially a contract that outlines the number of shares available for purchase/sale, the exercise (strike) price, and the expiration date.

The key difference between warrants and options is that the underlying asset is always shares for warrants, while options give the right, but not the obligation to buy or sell multiple other assets. Also, warrants are issued by companies, while options are issued by investors/traders.

Warrants trading debuted on the New York Stock Exchange on April 13, 1970. Despite facing challenges in gaining traction among investors initially, warrants are now widely recognised. In 2004, there were only 20 issues, but today they are listed on stock exchanges globally.

Types of warrants

Warrants are contracts that grant their holder the right to buy or sell shares at a predetermined price on or before a specific date. These derivative financial products are issued as securities and traded on the stock exchange.

The value of a warrant is linked to the price of its underlying asset (shares):

  • Call warrant – the holder has the right to buy the stocks at a later date.
  • Put warrant – the holder has the right to sell the stocks at a later date.

If anticipating a price rise, investors typically opt for call warrants, granting the right to buy (cheaper, after the price increases). Conversely, if they are anticipating a fall, investors opt for put warrants (so they can sell the stocks at a higher price, after the price falls).

Also, there is a key difference between European and American warrants. A European warrant can be exercised only on the expiration date. The American warrant can be exercised at any time before or on the expiration date.

What characteristics do warrants have?

Warrants have the following characteristics:

  • Although most warrants are issued by companies with stocks as the underlying asset, sometimes financial institutions, such as banks, may issue warrants with commodities or forex as the underlying asset.
  • Being leveraged products, they are quite risky for inexperienced investors as they can virtually lead to unlimited losses.
  • On LSE, all warrants are covered and are traded on UK blue-chip shares, commodities, forex, indices, and baskets of assets focusing on a theme or sector.

What aspects should be considered before trading with warrants?

When trading with warrants, considering various aspects becomes crucial for crafting an investment strategy that leads to desired success or, at the very least, avoids potential pitfalls. A pivotal aspect is recognising its nature as a financial derivative, meaning its value and liquidity depend on another financial product (the underlying asset).

Liquidity stands out as a primary advantage due to warrants' high availability in the market. This liquidity enables continuous trading conditions. In other words, you can trade warrants during LSE trading hours.

Furthermore, the price of warrants is also influenced by the underlying asset, time left until expiry, market sentiment, dividends, and changes in interest rates.

Warrants – glossary

To sum up, here is a short summary of the terms related to warrant trading:

  • Warrant price: The price at which a warrant can be bought or sold, known as the exercise or strike price.
  • Underlying asset: The asset that the warrant gives the holder the right to buy or sell on the expiration date (or before in the case of American warrants).
  • Exercise date: The future date for the execution of the purchase or sale transaction.
  • Premium: The price paid for the warrant itself. This consists of:
    • Intrinsic Value: The difference between the exercise price and its underlying asset.
    • Time value: Due to uncertainty (regarding the underlying asset's price), warrants with plenty of time left until expiry can be more expensive than those closer to the expiry date, which is known as time value.

Summary

Warrants are contracts linked to the price and availability of shares typically, but a few other assets, too. They are not a safe choice for beginners because they are leveraged products. If you want to learn more before risking your hard-earned cash, you may want to start with our trading guide and warrants guide instead.

However, for those experienced in derivatives, such as options trading, futures trading, or CFD trading, warrants represent a huge opportunity to take advantage of large swings in the market. To get started, have a look at our best brokers for intraday trading and the best trading platforms.

FAQs

Are warrants and options the same thing?

While both warrants and options offer the right to buy or sell assets at a set price, warrants are issued by companies and traded on exchanges, whereas options are standardised contracts traded on exchanges.

Can warrants be used for hedging investment risks?

Yes, warrants can serve as hedging tools to mitigate investment risks by allowing investors to take positions that offset potential losses in their portfolios.

What happens if I hold a warrant until its expiration date?

When a warrant reaches its expiration date, it becomes worthless if not exercised. It's essential to consider exercising or selling warrants before expiration to avoid losing their value.

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