What Is a Stock Warrant? Guide to Exercising Stock Warrants
It’s easy to learn how stock warrants work because they’re similar to options: A stock warrant offers investors the right, but not the obligation, to buy or sell a stock at a specific price by a set date.
That said, while it’s fairly easy to come by stock options, stock warrants are less common, especially in the U.S. Some investors may be familiar with stock warrants because they’re typically part of SPAC, or special purpose acquisition company, deals.
And although warrants and options do have some similarities (e.g. there are put warrants and call warrants), they also have substantial differences. Here’s what you need to know about how stock warrants work.
What Is a Stock Warrant?
Like a stock option, a stock warrant is a derivative contract that gives the holder the right, but not the obligation, to buy or sell the underlying security at the agreed-upon strike price on or before the expiration date of the contract.
Stock warrants are issued by the company that has the stock. They’re typically used as a way to raise capital, because the cost of the warrant (the premium) and the cost per share both flow to the company.
With U.S. warrants, the expiration date is the last date investors can exercise the warrant; with European-style warrants, the expiration date is the only date when investors can exercise their warrants. In the U.S. stock warrants typically don’t expire for a period of several years.
Investors pay a premium per share for the stock warrant (typically a fraction of the share price). Investors generally buy one warrant per one share of stock, but warrants can also be sold at a certain ratio, e.g. 4 to 1 (e.g. four warrants represent one share of the underlying security).
It’s important to know the terms of the warrant, so that you know what you’re buying, how much you’re paying, what it’s worth, and when the warrant expires.
Two Main Types of Warrants
Similar to options trading, investors can buy a call warrant or a put warrant. A call warrant allows investors to purchase shares from the company by the expiration date.
A put warrant allows them to sell the shares back to the company.
Stock warrants in general aren’t common in the U.S., especially with the decline of the SPAC market (more on that below). Put warrants tend to be less common than call warrants.
The Value of Warrants
Warrants have intrinsic value and time value, similar to options. Intrinsic value is how profitable the stock warrant would be if the investor exercised it now.
The time value of a warrant, put simply, is a function of how volatile the underlying shares are, and how much time is left until expiration. The more time the warrant has until it expires, the more time it has (potentially) to rise in value.
That’s why stock warrants can be traded on the secondary market.
When an investor exercises a stock warrant in order to purchase shares, the company issues new shares, which are dilutive to the existing shareholders.
Pros of Stock Warrants
The primary advantage of stock warrants is that for a relatively small upfront investment, investors have the right to purchase shares of stock — which, if they are lucky, may increase in value and deliver a substantial profit. The downside is that the warrant can expire worthless.
However, there is an advantage in terms of time: Stock warrants are often long-term — some are five, 10, or even 15 years. Ideally then, investors can wait for the best time to exercise their warrants.
Given the longer time horizon before warrants typically expire, investors can trade warrants on the secondary market, assuming the warrant still has value.
Cons of Stock Warrants
The leverage offered by a warrant cuts both ways, giving investors the potential for big gains or big losses — so these contracts can be quite risky.
Also, an investor may be entitled to dividends or have voting rights when they purchase actual shares of stock. That’s not true when investors buy warrants. Warrants don’t pay dividends and don’t offer voting rights.
Profits from selling stock warrants are taxed as ordinary income, which can be a higher tax rate for investors vs. the capital gains rate.
|The low price of warrants can lead to big gains.||Warrants can be risky, and a modest price drop in the underlying stock price can render the warrant worthless.|
|The longer time horizon gives investors the chance to buy/sell at the right time.||Stock warrants don’t pay dividends and don’t come with voting rights.|
|Investors can trade their warrants on the secondary market before they expire, if they still have value.||Profits from selling a stock warrant are taxed as income, not as capital gains.|
The Complexity of Stock Warrants
Investors should bear in mind that, above all, stock warrants are not as simple as they can seem at first. In some ways the terms of stock warrants are more opaque than stock options.
If a stock pays dividends, that may lower the price of the stock warrant (as an inducement to investors, who won’t see dividends, but may see a higher payoff). But a stock warrant can also be structured so the share price incrementally rises over time, which may not be favorable to the investor.
Stock warrants are typically not considered very liquid, because there are so few of them.
Stock Warrants vs Stock Options
Warrants differ from options in a few important ways:
1. A stock option is a contract entered into by two investors, whereas a warrant is issued by the company that issues the stock.
2. Stock warrants also differ from options in that they can have expiration dates as far as 15 years in the future. Most options last for much shorter periods, and rarely more than three years.
3. Warrants are a source of capital for the issuing company, whereas options are instruments traded between entities.
4. Call warrants and options give the holder the right to buy a stock; puts give the holder the right to sell a stock. But there is a difference between put options and put warrants in that put options may be more advantageous because their price goes up when the stock price goes down. If you buy a put warrant from a company and the price goes down to zero, you may not be able to sell your stock back to the company.
|Issued directly by a company||Traded between investors|
|Expiration dates as long as 15 years||Expiration dates typically less than a year|
|Source of capital for the company||Potential profit or loss for investors, not the underlying company/entity|
|Put warrants may be more risky than put options||Put options may be more advantageous than put warrants|
How Do SPAC Warrants Work?
SPACs, which stands for special purpose acquisition companies, are shell companies that raise money by listing shares on a stock exchange, and then merging with private companies that wish to go public.
When it comes to SPACs, investors who buy in during the pre-listing process are given “units.” Each “unit” includes a share and a warrant or a fraction of a warrant. The warrants are meant to be additional compensation to pre-listing SPAC investors for agreeing to have their capital held in a trust until the merger.
SPAC Market Declines
While SPACs saw considerable interest from investors a few years ago, with billions flowing into these deals, SPACs are not without their risks and there are no guarantees for those holding SPAC stock warrants. In 2022 alone, the number of SPAC mergers dropped by 22% — and the number of canceled SPACs doubled to about 55 last year.
In addition, historically institutional investors — hedge funds, mutual funds, and pensions — have had greater access to SPAC units, since units are allocated during the private placement stage of a SPAC deal.
This has been one of the criticisms lobbed at SPACs, with detractors arguing that it gives institutional investors a better risk-reward proposition than retail traders, who typically just buy regular shares in the market without the added potential value warrants can offer.
Recommended: SPAC vs. IPO
Example of Exercising SPAC Warrants
The SPACs’ shares “separate” from the warrants usually 52 days after the initial public offering or IPO. This allows unitholders to trade the warrants and shares separately. The fees for exercising or trading warrants can be more sizable than the fees for trading shares.
Here’s a case example of how an investor may exercise their SPAC warrant. A merger between the SPAC and the target company is completed, and 52 days later, the warrants become exercisable at their strike price, which is typically $11.50 in SPACs.
So let’s say the shares of the combined company are trading at $15, so higher than the strike price of $11.50. That means investors can exercise their warrants and buy additional shares at $11.50 and immediately sell them for $15.
The investor would then pocket the difference between the exercise price of $11.50 and the current share price of $15 for a tidy profit.
But if the share price is trading lower than the exercise price, the investor is in a wait-and-see situation — and if the share price never rises above the strike price, the warrants are essentially worthless.
Recommended: What to Know About SPACs Before You Invest in Them
Important Things to Know About SPAC Warrants
While SPAC warrants can be a lucrative opportunity, it’s also important to be aware that each SPAC and the terms of the warrant contracts need to be evaluated by investors on a case-by-case basis.
Remember, warrants offer an opportunity but they can also expire when worthless. For instance, it’s possible shares of the combined company never rise above the strike price of $11.50, making it impossible for investors to exercise the warrants.
Furthermore, the regulation of SPACs and their warrants could change. In April 2021, the Securities and Exchange Commission (SEC) changed how SPAC companies can classify warrants on their balance sheet. Many SPACs have considered warrants as equity. But under the new guidelines, in certain circumstances, SPAC companies need to classify warrants as liabilities.
Many SPACs in the pipeline have had to reevaluate their financial statements in order to make sure they’re in compliance with the new regulatory guidelines. Market observers interpreted the SEC’s move as an attempt to cool the red-hot SPAC market.
Why Do Companies Issue Warrants?
The reason that companies issue stock warrants is to raise capital without selling other bonds or stock. Selling warrants also protects the company’s stock from becoming diluted, as would happen with the issuing of new stock — unless or until investors exercise them. Call warrants will dilute the shares on the market when investors exercise them.
Recommended: Understanding Stock Dilution
Because warrants are less expensive than the underlying stock, unproven companies will use them to entice new shareholders. The company makes money on the warrant sale, and on the exercise of the call warrant if the owner buys the underlying shares. And if the warrant expires, the company keeps the purchase price of the warrant.
A company may issue call warrants as a show of confidence for shareholders who want to hedge their holdings of that company’s stock. The company offers the hedge of the call warrant to reassure shareholders while raising capital from the sale of the warrant.
Sometimes, companies will also issue warrants as a way to raise capital during periods of turbulence. For example, some companies issue warrants if they’re headed for bankruptcy.
How to Find Warrants to Invest In
Not every publicly traded company offers warrants. In the U.S. the companies that tend to issue warrants are not big Fortune 500 corporations. Instead, they tend to be smaller, more speculative companies.
While there are some online databases of warrants, they’re not necessarily comprehensive and up-to-date. But if an investor has a company they’re interested in investing in via warrants, they can contact that company’s investor relations department. Investors can also go to the company website and search for the word “warrant,” or the company’s ticker symbol, followed by “WT.”
Some warrants can also be traded under the symbol that includes the underlying stock symbol with either a “W” or “WS” before it. Once an investor finds a warrant, most online brokerage accounts will allow them to buy and sell the warrant.
How to Use Warrants
For an investor who owns warrants, the first decision is when to exercise the warrant. For a call warrant, that’s when the stock price has risen above the warrant’s strike price. If it’s a put warrant, then it means the stock is trading below the strike price.
But a warrant holder has another option, which is to sell the warrant on the open market because warrants can be traded like options. This is one thing to consider if a call warrant is below the strike price. Even if it’s below the strike price, the call warrant may still have intrinsic value right up until it expires, though the market may offer you less for the warrant than you paid for it.
Even if the current stock price is higher than the strike price, an investor may choose to hold onto the warrant. That’s because the price could rise even higher before the warrant expires.
Whether buying, selling, or exercising a warrant, most brokers can help an investor get it done. Once purchased, a warrant will appear in a trading account just like a stock or option. But with warrants, like most financial derivatives, most brokers charge higher transaction fees. After the broker contacts the company that issued the warrants and exercises them, the stock will replace the warrants in the trading account.
Other Important Things to Know About Warrants
It’s important to remember that every company that issues warrants does it differently. One company may issue warrants in which five warrants can be exercised to obtain one share of stock. Another company may set the ratio at ten to one or twenty to one.
Some companies can adjust the strike price of their call warrants if the company pays out dividends. This is a twist that can benefit the buyer because warrants with a lower strike price are more likely to be exercised at a profit.
But not every contractual term in a warrant is necessarily to an investor’s benefit. There are some call warrants whose structure allows the issuing company to force investors to sell their warrants if the stock price rises too high above the warrant’s strike price. There are even some warrants whose strike price is designed to rise higher over time, which makes it less likely that an investor will be able to exercise the warrant at a profit.
While it makes sense to study and understand the fine print before buying a warrant or any investment, it’s especially important to double-check those terms and conditions when getting out of the investment, by exercising a warrant, for example.
Stock warrants are a bit like their cousins the stock options — but there are some key differences to know. These often-overlooked securities can offer investors an inexpensive way to bet on the long-term success of a company. But they come with potential pitfalls, particularly when it comes to the fact that they can expire if investors don’t exercise them.
Warrants have become more topical since they’re issued in SPACs, which have seen an equally dramatic rise and fall in popularity over the last few years. In SPACs, early investors often get a share plus a warrant or partial warrant. However, investors should evaluate each SPAC and warrant carefully given the potential volatility of these arrangements.
All of that said, stock warrants are relatively uncommon as investment vehicles in the U.S. Investors can get their start by trading stocks — which is easy when you set up an account with SoFi Invest®. SoFi Invest offers an Active Investing platform that allows users to choose stocks and ETFs without paying SoFi commissions. Get started now.
What is an example of exercising a stock warrant?
Let’s say a stock is trading at $5 per share. The company decides to sell call warrants for a strike price of $5.50 per share. If the stock price rises to $6 per share before the expiration date, an investor could exercise their stock warrants to make $0.50 per share. If the stock price drops to $4.75/share, investors would have to wait rather than take the loss — and hope for a price increase before the warrant expires.
What is the purpose of a stock warrant?
Stock warrants are generally issued by a corporation as a means of raising capital. The company sells the warrants to investors, who have a specified period of time in which to exercise the warrant (say, five years). In the above example, the company would raise $0.50 per share by selling call warrants at a slightly higher price-per-share.
How can you find a stock warrant to invest in?
Trying to find a stock warrant over-the-counter from the issuing company isn’t impossible, but it can be difficult, especially because most companies don’t offer warrants. The easiest way to find stock warrants on the secondary market is to purchase them through your brokerage account. Warrants are indicated with a W or WS added to the ticker.
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