Warrant Definition: Day Trading Terminology
A warrant is an equity derivative that shares many of the same characteristics with options, but with a few key differences.
Just as in the case of a standard equity option, a warrant provides the holder with the right, but not the obligation, to buy a stock at a specified price, the strike price, either on the expiry date, in the case of a European style warrant, or on or before the expiry date, in the case of an American style warrant.
There are also exist “put” warrants, as opposed to the standard “call” warrants, that provide the right to sell at a specified price, but these are much more rare.
The Difference Between a Warrant and an Option
The defining difference between a warrant and a standard equity option is that warrants are written by the company themselves, and represent the offer of sale for newly issued equity that will dilute the existing equity shares.
As such, warrants are used in rare occasions when a company is seeking financing, and a complex derivative arrangement involving the potential creation of new stock is the ideal course of action. These deals usually involve a small number of large investors and the creation of warrants for relatively large amounts of stock.
While warrants are generally only transacted between the company and the primary investor, warrants do occasionally find their way into second hand markets. In these cases warrants can provide an attractive alternative to standard equity options, offering the same potential income for a much lower price.
However, investors should recall that if a large number of warrants are exercised, this can have an adverse affect on the price of the stock through dilution.
While most traders who are looking to take a derivative position with respect to a company will use standard equity options, it is important to remember that the alternative of warrants does exist, and it can occasionally offer the same basic exposure as standard equity derivatives for a much more attractive price.