Warrant (finance)

For other uses of the term Warrant, see Warrant (disambiguation)

A warrant is a security that entitles the holder to buy or sell a certain additional quantity of an underlying security. This transaction takes place over an agreed-upon price, exercised within a period of time and at the holder's discretion. The right to buy the underlying security is referred to as a call warrant; the right to sell it is known as a put warrant. In this way, a warrant is very similar to an option. When a warrant is exercised, a new share of stock is created, whereas when an option is exercised, the owner of the option receives an existing share that is delivered by a counterparty (except in the case of employee stock options, where new shares are created and issued by the company upon exercise).

Warrants vs. Options

For investors, options and warrants are very much the same, except for two major differences.

Issuance

Options are issued by independent parties, such as a member of the Chicago Board Options Exchange. Warrants are issued and are guaranteed by companies, such as a Special purpose acquisition company (SPAC), although they can also be issued by third parties. They are usually issued in “units” which combine them with common or preferred stocks to make the deal more attractive to investors. This is a common financing method for start-up companies to raise capital.

Sometimes the issuer will try to establish a market for the warrant and to register it with a listed exchange. In this case, the price can be obtained from a broker. But often times, warrants are privately held or not registered, which makes their prices less obvious. Once the warrants are in the secondary market, they can then be traded just like a stock. Warrants can be easily tracked by adding a “w” after the company’s ticker symbol to check the warrant's price.

Duration

Another difference between a warrant and an option is the duration of the contract. A warrant's lifetime is measured in years (as long as 15 years), while options are typically measured in months. Even LEAPS (long-term equity anticipation securities), the longest stock options available, tend to expire in two or three years.

Types of Warrants

Traditional

Traditional warrants are issued in conjunction with a Bond (known as a warrant-linked bond), and represent the right to acquire shares in the entity issuing the bond. In other words, the writer of a traditional warrant is also the issuer of the underlying instrument. Warrants are issued in this way as a 'sweetener' to make the bond issue more attractive, and to reduce the interest rate that must be offered in order to sell the bond issue.

Naked

Naked warrants are issued without an accompanying bond, and like traditional warrants, are traded on the stock exchange. They are typically issued by banks and securities firms. These are also referred to as covered warrants. The writer of a naked warrant need not be the issuer of the underlying instrument. A naked warrant is essentially an option with a very long time to expiry. Therefore an employee stock option is also equivalent to a warrant.

Government Issued

Also, when a government agency issues checks which they are unable to pay (due to lack of money) but are redeemable some point in the future, usually with interest, these are also called warrants. In the late 1990s, when the State of California had a budget crisis due to a disagreement between the governor and the legislature, the state treasurer was forced to issue warrants paying 18% interest in lieu of being able to pay the state's bills with real money. The state had not had to rely on this practice since before the Depression of the 1930s Many places were accepting them at face value because of the interest provision. It was interesting that during this period the Controller of Los Angeles County was buying state warrants to invest the county's surplus funds because the county, on the other hand, actually had money and the interest rate was better than any bank would pay.

In some U.S. states, a warrant is a demand draft drawn on a government's treasury to pay its bills. They are essentially checks (and are often referred to as such), but a different term is used as final payment is made by the treasurer instead of a bank. Most of these warrants have been replaced by checks or electronic payments, but in Arkansas they are still used by the state, and some counties and school districts, for non-electronic payments.