by Brandon Wendell, Online Trading Academy
Article of the Week from Online Trading Academy
Investors are constantly seeking out the best opportunities for earning profits on their investments. Most will research a company and then buy the stock of that company expecting to profit from the rise in price of the stock. There are many other ways of investing which, by employing more creative investment strategies, may allow investors to earn a higher rate of return.
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What Are Stock Warrants?
Stock warrants are an opportunity for investors to purchase stocks at a certain price without obligation to buy. If you think this sounds like an option trade, you are correct, warrants are similar to options.
Both call options and stock warrants allow the owner to purchase a set number of shares at a set price. There are also put warrants that, like a put option, allow an investor to sell stock back to the company at a set price. The price at which the shares can be bought or sold is called the strike price. Warrants are contracts that do allow for the purchase or sale of the stock at the strike price, but that transaction must be completed prior to the expiration of the warrant. All warrants have expiration dates, although the expiration may be as far out as fifteen years.
Exercising a stock warrant means that the investors has agreed to purchase the stock and must pay for the stock. There are two types of warrants, American style and European style.
American style warrants can be exercised whenever the holder chooses, prior to expiration.
European style warrants can only be exercised at the expiration of the warrant itself.
On rare occasions the two styles are combined. In this case, the warrant starts out European style and on a specified date through its maturity, takes on features of an American style warrant.
Types of Stock Warrants
Most warrants are issued by the company itself and are traded over-the-counter rather than on exchanges. When company issued warrants are exercised, new shares are issued to give to the buyer. This dilutes the ownership of shares as the new shares add new pieces of ownership to the already existing shares. There are a couple of ways company issued warrants are offered.
Warrant-linked Bonds
Stock warrants are often offered to make a bond purchase more appealing. In exchange for accepting a lower interest rate for the bond, the buyer will receive several warrants allowing for the purchase of stock at a set price. These warrants are often detachable. This means that the warrant can be sold in a secondary market by the owner without selling the bond.
Some warrant-linked bonds, called wedded or wedding warrants, may not be separated from the bond and, if sold, the holder must also surrender the bond at the same time.
Covered or Naked Warrants
Warrants issued by financial institutions are called Covered warrants and are sold from the financial institution’s existing inventory. These are not linked to bonds or preferred stock. There are no new shares issued and the ownership is not diluted. The warrants are covered by shares held by the selling institution.
Options vs. Warrants
As mentioned previously, warrants are similar securities to options. Both are contracts that allow the holder to buy a set number of shares of a stock at a strike price. The purchase of shares for both is known as exercise. Warrants and options have expiration dates and prices can change based on market conditions, and both decay in value with the passing of time.
However, while warrants are similar to options, there are also many differences.
| Options | Warrants |
| Expire in months or up to three years | Expire in months or up to 15 years |
| Traded through an exchange | Issued by companies or financial institutions and sold directly to the consumer |
| On exercise, existing shares are transferred | When company issued warrants are exercised, new shares are issued Institutional shares are covered by the institution |
| Sold as separate securities | Company issued are sold attached to bonds or preferred stock |
Risks and Benefits of Trading Stock Warrants
Purchasing warrants is not the easiest thing to do and may be something more suited to sophisticated investors. Since warrants are not traded on exchanges, investors would have to search for warrant information and perhaps subscribe to lists where they are available to purchase. Warrants can provide extra leverage to the investor but, in exchange, they are also riskier investments, especially in declining markets.
The advantage of purchasing or receiving a warrant is that it gives the investor the opportunity to buy the company stock at a discount to future prices. Of course, if the stock price drops below their strike price, the warrant would expire worthless and they would lose some or all of their investment. Receiving a warrant as part of a bond or preferred stock purchase has the potential to increase rate of return dramatically.
To learn more about investment opportunities and the chance to live your life with more freedom, visit your local Online Trading Academy center today. You can enroll in a workshop that will expand your knowledge on the financial markets and prospects for creating wealth and a better life.
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