Warrants give the buyer right but not obligation to buy (or sell) common stock of the company at a predefined price. In some respect, warrants are similar to the Call (Put) Options but there are some differences which we will talk about later in this post.
Like Options, Warrants are of two types – Call Warrants (right but not obligation to buy common stock) and Put Warrant (right but not obligation to sell common stock).
The fundamental concept of Warrants is similar to the Options. So, it gives the holder an option to buy (or sell) a certain number of common stocks at a predefined price (strike price) before a certain date. Obviously, a Call (Put) Warrant will be exercised only when the market price of the stock is higher than (or lower than) the strike price in.
Call Warrants are often issued along with debentures or preferred to sweeten the deal.
WARRANTS vs OPTIONS
1. Issued by the company itself
Options can be issued by anyone but Warrants are mandatorily issued by the company itself.
2. Dilution for current stakeholders
When a Call Option gets exercised the stocks which the holder gets were already issued by the company and traded in the secondary market (exchange). In the case of Call Warrant, the company needs to issues new stocks. This means that the Paid Up Capital of the company increases and the stakes of the current stockholders get diluted.
3. Longer trading cycle
Options are generally short term contracts (maximum 3 months). Even the Long Dated Options have a maximum of 3 years trading cycle.
Warrants can have much longer term even a decade or more.
WARRANTS vs CONVERTIBLE SECURITIES
Convertible Securities such as Convertible Debentures and Convertible Preferred Stock gives the option (can be mandatory, for example in case of Mandatorily Convertible Preferred Stock) to convert the security itself to common stock of the company. The securities have some intrinsic value before the conversion as well and the security holder may receive benefits. For example, the holders of Convertible Debentures may receive interest (coupon), the holders of Convertible Preferred Stocks may receive the dividend.
But, Warrants have no value in itself. The value of the Warrant is totally tied to the underlying stock. So, unless the market price of the underlying goes above the strike price, a Call Warrant is worthless. Similarly, a Put Warrant is worthless when the market price of the underlying is above the strike price.
Another important difference between Convertible Securities and a Warrant is that Warrants are often detachable from the Debenture or Bond it was issued with. If the holder of a Convertible Debenture sales the security, the option of the conversion also goes along with that. But, it is not the same in the case of a Warrant. The holder can sell the Debenture or the Warrant separately.