Public Traded companies issue stocks and warrants to raise capital and attract investors. A warrant allows investors to purchase a stock set at a specific price and date.
On the other hand, a stock option conveys the right to sell or buy the stock at a predetermined date and a certain price. Although options and warrants sound similar, they work differently and serve distinct purposes.
Knowing the difference between warrants and options can help you figure out which one to invest in. This post talks about stock warrants and options, advantages, similarities, and differences.
What Is a Stock Warrant?
A stock warrant can be seen as a derivative contract between an investor and a public company. Investors can purchase shares at a predetermined price and date through a warrant. The holders of warrants are not under any obligation to sell or buy the underlying stocks.
If companies want, they can issue stock warrants directly to investors so they can raise capital. An issued warrant always comes with a stock’s expiration date and the price at which it can be purchased.
Using a warrant, when an investor decides to purchase stock, the company can collect the money. An important thing to note here is that warrants carry a strike price. In addition, purchasing stocks is optional. Warrants don’t automatically assign ownership over shares of stock to the investor.
If an investor wants, they can buy stock but only at a price specified by warrant. So, investors can purchase the shares of a company at a discounted value if ever the stock is trading higher.
Ideally, any company can issue two kinds of warrants, i.e., put and call warrant. Using a put warrant, an investor can easily sell the stocks back to the company at a predetermined price and future date. Whereas call warranty lets investors purchase stocks at the current price and future date.
Perks of Investing in Warrants
Better Returns in Future for Strike Price
Warrants are great for investors who have a long-term investing perspective. Under the right market conditions and business fundamentals, the possibility of a company’s share price crossing the strike price is high. In the long term, companies earn higher profits.
Low-Cost Alternative to Standard Options for Underlying Stock Price
Compared to shares, warrants are more economical. In addition, they come with an alternate investment option to standard stocks. It helps investors make better profit from the dynamic circumstance and enhance the diversity of investments.
Better Management of Capital
Lastly, warrants offer a better opportunity to grasp an investment. It’s possible because warrants can also be divided into groups of shares like stock options.
While you can’t buy shares immediately, you get to purchase them at a fixed price. Therefore, investors can properly manage their capital.
Does Not the Obligation
The holders of warrants are not under any obligation to sell or buy the underlying stocks.
Disadvantages of Investing in Warrants
- As warrants have more volatility, they include more risk.
- Compared to shareholders, warrant holders are at a disadvantage as they don’t get to vote or they do not have rights to dividends.
- Warrants might suffer from a lack of availability.
What Is a Stock Option?
A stock option lets the trader sell or buy underlying asset stocks at a fixed price by a certain date. The price at which options can be traded is the strike price.
A trader needs to remember that stock options have expiry times. If the options are not exercised before the expiry time, the investor loses their right to sell or buy the contracts.
Options do not require investors to exercise them. It’s important to know that an investor owning an option doesn’t automatically own the underlying asset. Stocks options offer two categories to choose from: put and call.
Through call options, investors can purchase an underlying stock’s shares that are available at a set price. If you think that the underlying stock’s price will increase, you must choose to invest in call options.
However, investors sell the stock shares at a set price through the put option. Investors should only buy put options if they think the underlying stock’s price will decrease.
Advantages of Investing in Stock Option
At certain times, option buying can prove riskier than having equities. So, risk can be reduced or increased depending on how you use options.
Since options have minimal financial commitment than equities, they are less risky for investors. The risk level is also low because options have relative imperviousness to potentially catastrophic effects of gap openings.
Compared to stocks, options are a more dependable form of hedge. A stock-loss order is placed to protect the position when an investor purchases stocks. The stop order is placed below a predetermined price to stop the losses.
Higher Potential Returns
When you trade options, you can expect a higher percentage return.
One of the main reasons traders like options is that it is highly volatile. High volatility results in better profits.
Disadvantages of Investing in Options
- Options trading can be risky, and you might lose all your money as the government does not guarantee it.
- Options come with an expiration window. When an option reaches this expiration time, you can no longer trade them.
- In options trading, a person might lose more than the trade.
Warrants vs. Options: What’s the Difference?
Warrants and options might sound the same to some traders, but they are different. They are made available to investors in different ways.
In the case of warrants, a company issues them directly to the investors. In contrast, stock options can be traded on an exchange like shares of stock. If ever an investor wants to purchase stock via warrant, the proceeds go to the company. But when an investor trades an option, the money is traded to another investor.
In short, warrants offer direct benefits to the company, but options offer benefits to the investors involved in the transaction. Furthermore, warrants and options can be issued at different strike prices where they have different expiration dates.
A warrant is better for long-term investment. Companies might allow investors a decade or more so that they can decide whether they want to purchase shares or not. But options are short-term in nature. They have expiration dates that might be a few months or days in the future.
Below are some more differences between options and warrants:
- An option can be seen as an agreement because traders have the right to sell or buy stocks at a certain price and date. But they are not obliged to do so. On the other hand, a warrant can be seen as an instrument that offers the buyer the right to get a certain number of shares at a fixed price and date.
- Options are more of a standard contract as they follow the rules governing exercise price, maturity, size of the contract, and duration. However, warrants are securities.
- Warrants are known to get issued by a specific company. But options are issued by the exchange, such as the U.S. Chicago Board Options Exchange.
- The warrant is a primary market instrument because a company issues it. On the other hand, stock options are secondary market instruments as trading takes place between investors.
- The maturity period of warrants is around 15 years. But options have until two years.
- Warrants have securities like international shares and currencies. In contrast, options have underlying assets, including bonds, domestic shares, and indices.
- A company does not receive any direct benefit in the case of options as the profit is passed to investors. However, a warrant offers profit to a company. In fact, the company issues warrants for increasing the sales of shares. Also, the company offers a hedge against a fall in the firm’s value.
- Warrants can result in dilution, which can create the issuance of new stocks, but this does not happen in options.
- To trade warrants, traders need to follow the principle of cash markets. But to trade options, traders should follow the feature market.
- Warrants are issued by combining with other instruments like bonds, but options are issued independently.
- Options are not taxable in nature as they are subject to rules governing compensatory items. But warrants are taxable in nature.
Are Warrants or Options Better for Investors?
When you are comparing warrants and options, it’s essential to keep in mind that either one’s benefit does not rule out the advantages of the other. Which among the two is the right fit for you completely depends on your risk tolerance, investment strategy, and time horizon.
Stock warrants should be your pick if you are planning a long-term investment. Companies offer traders to take advantage of the warrant for years. You can use the time to analyze how the stock pricing will be affected by market movement. Doing this can help you know the best time to exercise, put or call a warrant.
On the other hand, options are ideal for day traders and short-term traders who want to earn quick profit from the market. While options trading can offer quick results, it is risky as the underlying security’s price movement is not guaranteed.
As options can be traded on an exchange, they are more accessible for traders. One can start trading options almost immediately after opening an online brokerage account. But warrants are harder to come by as they are sold over the counter. Depending on how the warrants are priced, they can offer better profits.
Trading experts recommend allocating money to options and warrants and splitting the difference in the investment portfolio. It can help in reducing the risk and creating better purchase opportunities. You can sell stocks above market price or purchase them at a discounted rate.
Options vs. Warrants – Similarities
While options and warrants are different, they share a few similarities.
- Whether it warrants or options, both offer an opportunity to the traders to enhance their exposure. They let the trader take advantage of stock market movement without possessing assets.
- They allow the traders to purchase a specific amount of assets at a specific date and fixed price.
- Both option and warrant offer rights to traders over the principal asset unless it is traded.
- Similar factors are known to influence the value of warrant and option. These factors include exercise price, time to expiry, risk-free interest rate, and implied volatility.
- In terms of pricing, options and warrants have similar components, i.e., time value of money and intrinsic value.
Tips for Investing
Whether you are investing in warrants or options, these tips will be helpful.
- You can talk to a financial advisor to know the pros and cons of options vs. warrants. In addition, you must know how to invest in either one. If you don’t know any financial advisor, you can easily find one by searching online or getting recommendations.
- An online broker can help you buy stock warrants or options. However, not every broker offers warrants or options to trade. Therefore, before you open a brokerage account, you need to compare the features offered by different platforms. Besides comparing the features, it’s also important to check the fees that the platform is charging.
- You can decide whether to trade in an option or warrant using different indicators. Technical indicators can be used for knowing the market movement and trends. On the other hand, fundamentals can offer a company’s financial health insight. Fundamental analysis can help you know whether to purchase the underlying stocks or not if you are investing as a buy-and-hold investor in warrants.
Frequently Asked Questions
Are warrants better than options?
Warrants are known to last for around 15 years, but options can only last from a few months to years. So, for long-term investors, warrants are better.
Do warrants have time value?
Warrants are known to have time value. Therefore, the longer the warrant stays, the greater its value is.
You can use warrants and options to diversify your portfolio. While both of them have differences, they share similarities as well.
Warrants are recommended for long-term traders, and options are great for short-term traders. Although options can help in gaining quick profit, it is also risky.
Companies offer warrants as a way to raise capital. Investors can use options and warrants to reap profits. Traders can structure warrants and options by selling or buying (not both). Lastly, it’s advised to know the pros and cons of options vs. warrants to decide which is better for you.