Warrants explained: types, prices, and how they work

In the world of investment, there are many financial products that you can buy and sell to make money. From stocks to more complex derivative products, the possibilities are virtually unlimited.

Specifically, derivative products are instruments whose value is based on the price of an underlying asset. Therefore, if you invest in derivatives, you are not directly purchasing the asset (the stock, commodity, or currency, for example) but rather you are speculating on the future price movements of the asset.

In this guide, we'll introduce you to warrants, what they are, what types exist, their prices, and how they work.

What are warrants?

A warrant is a financial contract that gives you the right, but not the obligation, to buy or sell a set number of shares at a set price (strike price) on a future date. This way, you can lock in a price for the shares, benefiting if the share price changes in your favour.

You can buy and sell them as often as you wish, and their price will change based on how many people want to buy or sell that specific warrant. This makes them a sign of how investors feel about the market.

Warrants are contracts that are essentially linked to stocks. They are issued by companies (not investors, like with options).

The key terms related to warrants:

  • Premium: the cost of the warrant.
  • Parity: number of warrants required to exercise the right on the given underlying stock. For example, a parity of 10 on a call warrant means that you need 10 warrants to buy 1 share at the exercise price.
  • Strike price: each warrant has a “strike price”, which is the predetermined price of the share to be bought or sold at the predetermined future date.
  • Expiration date: the date on which the warrant contract expires.

Warrants are listed on the London Stock Exchange and many other stock exchanges around the world, unlike options (which are typically listed on specialised options exchanges).

Characteristics of warrants

The most important characteristics of warrants are:

They are leveraged products

Leveraged means that you can potentially buy a larger amount of shares for a small initial investment. As with other leveraged products, this comes with both high risks and high potential for profit. Here is how it works:

  • A warrant requires you to pay the price to buy or sell the underlying stock at a later date. This price is usually much lower than buying the shares directly right away (hence, the opportunity for profit).
  • If the stock price moves in the direction you predicted, the value of the warrant can increase by a higher percentage compared to the stock. This means you can make more money relative to your initial investment.
  • On the flip side, if the stock moves against you, the value of the warrant can decrease more quickly, leading to higher losses compared to owning the stock.

Overall, warrants are considered leveraged products because they allow you to potentially gain or lose a large amount relative to your initial investment.

They offer the right to buy or sell

Warrants offer you the right to buy or sell an asset, but not the obligation to exercise it. If the price moves against you, you don't need to buy or sell the underlying asset, and the contract expires. In this case, you only lose the premium you paid for the contract in the first place.

Keep in mind that warrants are dilutive. In other words, when you exercise a warrant, you get newly issued stock (not outstanding stock). Also, the expiration date is usually years away from the issue date.

Asset choice

While it is true that warrants are issued by companies and give the right to buy or sell equity, they also provide access to other assets, such as commodities or currencies. These warrants are often created by financial intermediaries, such as banks, or specialised trading firms.

Investors often use warrants to hedge against downside risk – such as opting for a put warrant if they have a long position in the underlying stock. A practical example of using warrants will be discussed below.

Types of warrants

In general, warrants are of two types:

  • Call warrant: You obtain the right to buy the underlying asset at a certain date and at an agreed price. So, if the market price of the stock you want to buy rises, you can exercise the call warrant and buy it at the (cheaper) strike price.
  • Put warrant: You obtain the right to sell the underlying asset at a certain date and at an agreed price. So, if the market price you want to sell drops, you can exercise the put warrant and sell it at the (higher) strike price.

In addition to these two types of warrants, depending on their operation, they can also be classified into:

  • European warrant: The warrant can only be exercised on the expiration date.
  • American warrant: The warrant can be exercised at any time on or before the expiration date.

On the London Stock Exchange, you can only find covered warrants – the issuer, in this case, is a financial institution (rather than a company):

  • Stock warrants that focus on UK blue-ship shares.
  • Commodity warrants to take positions in sterling and on commodities in small sizes.
  • Basket covered warrants that focus on a theme or a sector (a group of stocks)
  • Currency warrants that focus on different exchange rates.
  • Index warrants (FTSE 100 is the most popular underlying index).

Price of warrants

The issuer of the warrant calculates the price against the underlying asset using automated pricing models. These include the Black-Scholes model and the binomial method.

Depending on each particular security, the warrant price can be influenced by:

  • The price of the underlying asset
  • The time left until the expiry date
  • The exercise price of the warrant
  • Volatility of the underlying asset
  • Dividends
  • Interest rates
  • Exchange rates

For warrants listed on the LSE, all issuers must provide a maximum percentage spread and a minimum dealing size.

How do warrants work? | Practical example

Let's assume there is a company called XYZ, and its shares are currently trading at £50 each. You believe that XYZ is going to release a new product soon that will make the share price go up. However, you don't have enough money to buy many shares, or maybe you don't want to risk a lot of money.

So, instead of buying shares, you buy a call warrant for XYZ that has a strike price of £55 and an expiration date three months from now. The premium (the cost to buy the warrant) is £5 per warrant.

  1. You buy 10 call warrants at £5 each, spending a total of £50.
  2. Two months later, XYZ announces its new product and the share price of XYZ goes up to £70.
  3. Now, your warrants give you the right to buy XYZ shares at £55, even though they are trading at £70.
  4. You exercise your 10 warrants. This means you can buy 10 shares at £55 each, spending £550. You now own shares that are worth £70 each, so their total market value is £700.
  5. You sell the shares right away for £700. After accounting for the £550 you spent to buy the shares and the £50 you spent on the warrant, you've made a profit of £100.

In this example, by using a warrant, you were able to make a profit from the rising share price of XYZ without having to buy the shares at their original price. This is a basic example and doesn't include some costs like fees or trading commissions.

Brokers to invest in warrants

If you want to start investing or trading warrants, here are the best brokers for warrants in the UK:

IG

IG is an online broker belonging to IG Group, which is listed on the London Stock Exchange. Its size and experience make it one of the brokers that gives investors the most confidence to trade with financial derivatives, such as warrants.

The platform offers the possibility to invest in warrants. Through warrants, you can access indices, stocks, commodities, and forex (currencies).

  • 🏆 Regulation: FCA
  • 💼 Financial assets: Warrants and many other assets
  • 💲 Costs: Variable
  • 📈 Platform: MT4, ProRealTime, proprietary IG platform, and more

These are the pros of investing in warrants through IG:

High quality, prompt customer service
Wide choice of trading platforms
Access to many underlying assets (such as indices, stocks or forex) through warrants
Quality resources and educational section

Cons:
Broker is not recommended for beginners due to the complexity of its assets. Remember that leveraged products carry a high risk of losses.

Have a look at our in-depth IG review for more information.

DEGIRO

DEGIRO offers the possibility to invest in warrants on stocks and indices, among others.

  • 🏆 Regulation: FCA
  • 💼 Financial assets: Warrants and many other assets
  • 💲 Commissions: €2 commission + €1 handling fee for structured products
  • 📈 Platform: Proprietary platform

The advantages of investing in warrants with DEGIRO:
Wide variety of markets
Many real assets
Beginner-friendly trading platform
Transparent fee structure

Disadvantages :
No demo account
No forex

For more information about this broker, visit our DEGIRO review.

Interactive Brokers

Interactive Brokers offers trading of warrants on different market centres. The fees are variable, but overall you can access warrants on stocks or indices listed in France, Germany, Switzerland, and Italy.

  • 🏆 Regulation: FCA
  • 💼 Financial assets: Warrants on stocks and indices
  • 💲 Commissions: Variable
  • 📈 Platform: Proprietary

Here are the main advantages of this broker:

Highly regulated and transparent broker
Wide variety of warrants (on stocks and indices)
Access to many products and markets

Disadvantages :
Platform may appear quite complex to beginners
Only has warrants on stocks and indices

Have a look at our Interactive Brokers review for more information.

What are the differences between warrants and options?

From everything we have explained, it might seem that warrants and options are essentially the same, but the reality is that there are some differences:

  • Access: you can trade warrants on the stock exchange, while options are often available via specialised centres instead.
  • Issuer: warrants are issued by companies or financial intermediaries, while options are issued by investors.
  • Expiry date: warrants often have many years until expiry date, options may expire in a few weeks or months at most.
  • Rights: warrants do not give dividends or voting rights. Options do not have them either, but if you exercise the option and buy the stock, you will get these rights.
  • Conversion: warrants can be converted into the underlying asset. Options cannot be converted, but rather you can buy the asset by exercising the option (and paying the strike price).
  • Dilutive: Options do not dilute because they are issued by two parties, while warrants are dilutive (the company issues new stock).

Pros and cons of warrants

Finally, let's look at the advantages and disadvantages of trading with warrants.

Pros of warrants:

  • ✅ Leveraged products
  • ✅ Variety of strategies: warrants allow you to benefit from both price increases and decreases of an asset, or to hedge portfolios.
  • ✅ Multiple options: warrants allow you to access a wide variety of markets

Cons of investing in warrants:

  • ❌ Complex products that are risky for beginners.
  • ❌ Tracking dates: you need to monitor them continuously to make sure your strategy is on track.

Read more about derivatives

Summary

All in all, warrants are contracts that give the right, but not the obligation, to buy or sell an asset at a specified price and on a predetermined date. These financial derivatives, whose value is based on an underlying asset, offer leverage and access to a wide variety of markets.

However, their complexity and associated risk require a deep understanding of the markets and constant monitoring. Essentially, they are powerful investment tools but demand caution and extensive financial knowledge.

FAQs

Who issues warrants, and why?

Warrants are usually issued by financial institutions or the companies themselves. Companies might issue warrants to attract more investors or as part of a fundraising strategy. When you buy a warrant, you're essentially lending money to the issuer with the chance to potentially buy shares later, often at a favourable price.

Are dividends paid on warrants?

No, owning a warrant doesn't entitle you to dividends. Dividends are payments made by a company to its shareholders, and since a warrant only gives you the right to become a shareholder at a future date, you won't receive any dividends until you exercise the warrant and own the actual shares.

Can I lose more money than I initially invested in warrants?

The most you can lose when buying a warrant is the amount you have spent to purchase it, also known as the premium. If the warrant expires worthless—meaning it's not profitable to exercise it—you lose the premium you paid, but you won't lose more than that initial amount.

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