Stock Warrants: What They Are and How They Work

Stock warrants vs. stock options

Stock options are contracts between two parties that give the holder of the option the right to buy or sell the underlying stock at a set strike price by a deadline. The seller of call options is often required to hold the underlying stock in their portfolio for the duration of the option.

That certainly sounds a lot like a warrant, so let's explore the key differences:

• Issuer: Most warrants (with an exception we'll discuss below) are issued by the actual business, and when exercised, the business issues new stock for the holder to buy. Options contracts are set up by two parties unrelated to the business, such as a stock broker. When an option holder exercises the option, the shares will change hands.
• Calls and puts: Calls give the holder the right to buy a stock, and puts give the holder the right to sell a stock. Put warrants do exist and allow investors to hedge their investments when buying new issues, but they are not as popular as put options or call warrants. The main advantage of put options is that their price goes up when the stock price goes down. If you buy a put warrant directly from the company and the price goes all the way down to $0, you may not be able to sell your stock back to the company.
• Term: Long-Term Equity Anticipation Securities (LEAPS) are the stock options with the longest terms. Most LEAPS do not offer terms greater than two years. This limits the time value of the option, which means investor upside is capped at a lower number. Warrants, on the other hand, can have a term of up to 15 years. That's a long time for the underlying stock to rise well above the strike price of the warrant.
• Capital: The final difference is that warrants represent future money that will be invested in the company (as long as the stock price stays high enough). When warrant holders exercise their warrant and buy shares, that money goes into the company's coffers.

Types of stock warrants

There are different types of warrants that have subtle tweaks from the type discussed above. Let's go over the different types.

• Traditional: Traditional warrants are calls that give investors the right (but not the obligation) to buy the underlying stock from the company at a set strike price before the expiration date.
• Put warrants: Put warrants operate like traditional warrants but give investors the right to sell their stock back to the company at a strike price. This type of instrument allows investors to hedge their stock position. If the stock price falls below the strike price, they can still sell at the strike price.
• Wedded warrants: Wedded warrants are attached to another security, usually bonds or preferred stock issued by the subject company. If the investor chooses to exercise the warrant, they must also relinquish the bond or preferred stock to the company.
• Covered warrants: Also known as naked warrants, these aren't issued by the underlying company. Instead, they are issued by a financial institution that holds stock of the underlying company on its balance sheet. Covered warrants effectively act like stock options where the counterparty is a major financial institution.