If you understand call options and how they work then you are well on your way to understanding a stock warrant. They share many of the same characteristics, at least at a definitional level. Similar to a call option, warrants have a strike price and an expiration date, but unlike a call option neither the strike price nor the expiration date are standardized.
These terms are set forth in the company’s SEC filings and can usually be found using a Bloomberg terminal, or by speaking with your broker (who can then look it up on a Bloomberg terminal).
Warrants can be either publicly traded or issued in a private placement transaction. If they are publicly traded they will trade on a stock exchange just like a stock. Warrants trade in shares as a stock does, not contracts as a call option does.
Warrants are generally issued with an expiration date that is between three and five years of the original issue date. There may also be a time period immediately after issue in which the warrants are not exercisable. For example, a warrant may be issued with this description: “This warrant is exercisable for a term of three years beginning six months from the issue date.”
Warrants can be issued for a large variety of reasons:
- Warrants can be issued when a company goes public, so that the warrants begin trading at the same time as the stock IPO
- Warrants can be issued after a company is public to raise additional capital
- A court may order the issue of warrants as part of a settlement or decision of the court, and
- Warrants may be granted in a takeover or spinoff
One unusual characteristic of a warrant, unlike a listed option, is that the terms of the warrant can be changed by the issuing company. This is not a normal practice, but it can and does happen, but in most instances the change in terms is beneficial to the warrant holder. The goal of the company issuing the warrants is to have them exercised, bringing additional capital to the company. For this reason a change in terms, should it happen, is normally either an extension of the time granted to exercise the warrants or a reduction in the strike price of the warrants.
Warrants can be used by an investor as an investment vehicle, just like a common stock. They may also be used to hedge another related position, or as an arbitrage component in a position involving either the common stock or options on the common stock. A warrant can be a valuable financial tool, and adds an additional avenue by which to invest or trade the company issuing the warrant.