What’s the difference between a stock warrant and a stock option? For starters, a warrant gives the stock holder the right to buy a company’s shares at a set price on a given date. When a stock warrant is purchased, the shares that are provided to meet the obligation come from the company, not another investor. When it comes to stock options, a contract is created between two investors giving the stock holder the right, but not the obligation, to purchase or sell the stock at the given price and date.
A few key ideas to make note of when it comes to warrants vs. options include the following:
- A stock warrant is issued by the company, not an investor.
- A stock warrant documents the right to buy a company’s stock at a set price and date.
- Investors purchase stock options when they believe the stock is in a volatile stage.
- Investors usually trade options between each other.
- A stock warrant provides future capital for the company that issues the stock.
Defining Warrants and Options
Options are stocks that are bought by investors when they foresee a price increase or decrease of the stock. Whether it’s based on a decrease or increase depends on the type of option. For instance, if a stock is currently trading for $30 and an investor thinks the price will increase to $40 in the next month, then the investor will likely purchase a call option today so they can buy the stock for $30 the next month and then sell it for $40.
Stock options are similar to stocks in that they also trade on a securities exchange. When stock options are exercised, they usually trade between two investors.
Warrants are a source of capital for the stock’s issuing company. When an investor purchases a stock through the use of a warrant, the proceeds go to the company. When the warrant is exercised, the investor receives a warrant certificate. This certificate lists the terms of the warrant, including the expiration date. While a warrant gives a right to a stock, it does not provide immediate ownership of the given stocks. Rather, it simply means that the investor has the right to buy a company’s stocks at a set price.
There are two types of warrants: a put warrant and a call warrant. A put warrant gives an investor the right to sell back stocks at a set price in the future, while a call warrant gives an investor the right to purchase stocks at a set price in the future.
Differences Between Warrants and Options
There are two primary ways that a warrant differs from an option. First, warrants are issued directly from a company. Second, new shares are issued for the warrant transaction. If a company is looking to raise some extra capital using a stock offering, it might choose to issue a warrant. For example, if a company sells its stock at $50 while a warrant is only $5, investors will be more likely to exercise a warrant.
Essentially, stock warrants provide investors with a means to own stock in a company at a price lower than a stock option. When investors exercise their warrants, they help the issuing company raise capital via equity.
Like securities, options are listed on the stock market exchanges. When options are traded, because they are on exchanges, the company of the stock does not actually make any money from those transactions. Another difference between the two is their lifespan. Warrants tend to be more long term, lasting for up to 15 years. Options, on the other hand, are more short term. They usually exist for only a month but will occasionally last up to three years.
Investors in search of long-term investments might find more worth in warrants because of their longer lifespan, while those looking for a quick profit will find a stock option more enticing. In the end, both warrants and options are great investments for earning a profit or hedging a loss due to a share’s price change.
Similarities Between Warrants and Options
While there are many differences between warrants and options, there are also quite a few similarities. The biggest similarity is that both a warrant and an option give the buyer the right to purchase or sell shares of the given stock at a fixed price on a specific date. There are also call and put warrants that operate a lot like call and put options.
Although the lifespans are different, a stock warrant and a stock option both provide investors with the ability to profit off a stock’s price change without actually owning the stock. Furthermore, neither a warrant nor an option gives the buyer any form of control over the stock until it’s exercised. Each also has a standard lifespan, an expiration date, and a fixed price.
When you break warrants and options down to their basic components, you’ll find they’re made up of the same things. They both have a time value and an intrinsic value. The intrinsic value is determined by totaling the difference between the market price of a stock and the exercise price listed on the warrant or option. The time value is used to evaluate the likeliness of a stock trading above its exercise price prior to the contract’s expiration date. This value is determined by totaling the difference between the price of the warrant or option and its intrinsic value.
Lastly, the factors that influence both warrants and options tend to be the same. For example, the exercise price, amount of time until expiration, implied volatility, underlying stock price, and interest rate all play a role in determining the value of options and warrants.
Choosing Options or Warrants
While both options and warrants have their pros and cons, stock options tend to be the more common trading strategy for a number of reasons. For one, options can be used in a larger variety of trading strategies than warrants. Options are also easier to purchase and sell because they are traded on public security exchanges. Warrants take more effort because they are sold over the counter. Furthermore, options provide more versatility and can be used to create spreads by purchasing and writing contracts.
While warrants aren’t the more popular choice, they do come with their own set of benefits. One such benefit is the potential for significant capital gains. Warrants’ prices are typically lower, which means they offer a possibility of a much larger profit. During a bull market, these profits have the potential to take off even more than normal. On the other hand, during a bear market, warrants can provide investors with some additional protection.
When building an investment portfolio, stock warrants offer a wise addition for most investors. They also provide smaller investors with the means to mix up their investments without jumping into the more competitive stocks.
Just like every other investment type, warrants also come with some risk. As with any type of investment, the potential for larger gains also means a potential for greater loss. One way warrants result in a loss is when the value of the certificate decreases to zero. If this happens before the warrant is exercised, any potential value is lost. Lastly, unlike a stock option, warrants do not provide the buyer with any voting, shareholding, or dividend rights within the company.
If you’re looking to make some new investments and are considering both stock warrants and stock options, make sure you understand the benefits and risks that come with both. A great way to gain a better understanding of options and warrants is to ask the pros at Raging Bull. At Raging Bull, you’ll find a host of great resources, including a free stock trading starter pack. Whether you choose warrants or options, the experts at Raging Bull can show you the ropes so that you hit the ground running.