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If you understand call options and how they work, then you are well on your way to understanding a stock guarantee. They share many of the same characteristics, at least at the definition 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 out in the company’s SEC files and can usually be found using a Bloomberg terminal or by talking to your broker (who can then look them up in a Bloomberg terminal).
Warrants can be publicly traded or issued in a private placement transaction. If they are publicly traded, they will be listed on a stock exchange as if they were stocks. Warrants are traded in shares like a stock does, not in contracts like a call option does.
Generally, warrants are issued with an expiration date of three to five years from the original issue date. There may also be a period of time immediately after issuance in which the warranties are not exercisable. For example, an order can be issued with this description: “This order is exercisable for a period of three years from six months from the date of issuance.”
Warrants can be issued for a wide variety of reasons:
- Warrants can be issued when a company is publicly traded, so that the warrants begin trading at the same time as the initial public offering of shares.
- Warrants can be issued after a company goes public to raise additional capital.
- A court may order the issuance of court orders as part of a court agreement or decision, and
- Warrants can be granted in an acquisition or spin-off
An unusual feature of a warranty, as opposed to a listed option, is that the issuing company can change the terms of the warranty. This is not normal practice, but it can and does happen, but in most cases the change of terms is beneficial to the authorization holder. The objective of the company that issues the warrants is to exercise them, providing additional capital to the company. For this reason, a change in the terms, should it occur, is normally an extension of the time granted to exercise the warrants or a reduction in the exercise price of the warrants.
Investors can use warrants as an investment vehicle, just like ordinary shares. They can also be used to hedge another related position, or as an arbitrage component in a position involving common shares or common stock options. A warrant can be a valuable financial tool and adds an additional avenue by which to invest or negotiate with the company issuing the warrant.
