What is a warrant and how does it work?
A warrant is a type of derivative which gives the holder the right to buy or sell a security, considered an equity, at a specific price before expiration. When companies issue warrants, they will have their own unique exercise conditions which is predetermined by the company. For example, companies in the USA would generally issue warrants which can be exercised anytime before the expiration date, whereas companies in Europe would generally issue warrants which can be exercised only on the expiration date.
What is the difference between a warrant and an option?
Although relatively similar, there are some key differences. The first being that warrants are dilutive, meaning that for the company to issue new warrants, new shares must be issued first in reserve to make room for the warrants. Options on the hand are non-dilutive, meaning that investors would buy or sell options with conditions attached to existing shares on the market. Also, warrants are issued by the company, whereas options are written by investors holding already-outstanding stock. This means that with warrants, the shares attached to the warrants are obligated from the company as opposed to options which is reliant on the investor which issued the option.
What does a company get from issuing a warrant?
Generally, companies issue warrants attached to a bond to get better conditions on a bond such as lower interest rates. The warrant acts a sweetener for investors and are often detachable from the bond which means that they can be sold on the secondary market before expiration. Companies also issue warrants as a source of capital, this is because when investors use their right to convert the warrant into a stock, the company has to issue new shares which is bought by the investor leading to increased cash coming into the company.
Warrants Case Study
Warrants are seen by many as a leading indicator of a stock. Once the warrants are issued, investors will have a period before expiration where they will decide if they want to use their right to convert the warrant to become a stock at a specific price. Let’s look at Company A as an example.
Chart 1 represents the stock price of Company A from Jan 2021 to present day, what we can see from the chart is that as time passes, the stock price is constantly decreasing.
Chart 2 shows the price of the warrant form of Company A Jan 2021, and what is obvious is that they are almost identical. When the stock price increases, as shown in March 2021, we can also assume that the price of the warrant will also increase as investors believe that there is a higher chance of the warrant being converted to stock, making it more valuable. Over time, as the stock price decreases, so does the warrant. This is because as we move towards the expiration date, there is a lower chance of the stock reaching the strike price, making the warrant less valuable.