The ownership of a company is called equity, the difference between what a company owns and what it owes -- assets minus liabilities. You’ll find different types of equity on a corporate balance sheet, including retained earnings, common stock, preferred stock and stock warrants. Warrants are similar to call options, but they're not identical.
A stock warrant give its owner the right, but not the obligation, to purchase a certain number of stock shares for a given price -- the strike price -- on or before an expiration date. Warrants differ from call options in a few ways. Traders write call options and must deliver shares from the secondary market when a buyer exercises a call or the option expires “in the money.” When you exercise a warrant, the shares normally come from treasury stock of the issuing company. That means warrants dilute earnings per share by creating new outstanding shares, whereas options do not. Options usually expire in weeks or months, but a warrant may have an expiration date five or 10 years after issue or no expiration date at all. Standardized options trade on exchanges; warrants need not be standardized and can trade over the counter or on exchanges. Some of the largest warrant markets are in Hong Kong, Korea and Singapore.
The calculation of a warrant’s price uses a variation of the Black-Scholes model that traders use to price call options. The model is a complex formula that incorporates the price of the underlying stock, the strike price, the risk-free interest rate, the volatility of the underlying shares and the time until expiration. Intrinsic value occurs when the underlying stock's market price exceeds the strike price, because you can exercise the warrant at the strike price and immediately sell the shares at the market price, pocketing the difference. Time value derives from the possibility that a warrant will gain intrinsic value before expiration. Time value dwindles to zero by the expiration date.
A warrant may convert into any whole or fractional number of shares. The conversion ratio multiplied by the current stock price gives you the conversion value -- the total value of the shares you’ll receive if you exercise the warrant. Warrants have only time value as long as the underlying stock price is below the strike price -- “out of the money.” It costs less to buy the shares in the secondary market than through this warrant. The warrant “premium” equals what you paid for the warrant plus the strike price minus the current share price, all divided by the current share price and then multiplied by 100. A premium of zero is the warrant’s break-even price; negative premiums show the percentage gain you’ll achieve by exercising the warrant.
A corporation might issue stock or bonds with attached warrants as a unit. The warrants “sweeten” the attached securities by giving investors a chance to profit from a rising stock price. In this case, the initial price of the warrant is the difference between the price of the unit and the price of the detached security. The fair value of a warrant to its holder is the price the warrant would fetch if sold at auction, but because warrant sales are often private transactions, the actual price may vary from the fair value.
- Value Stock Guide: What Are Stock Warrants? How Do They Work?
- Hong Kong Securities and Futures Exchange: Hong Kong’s Derivative Warrants Market -– Moving With Times Amid Rapid Developments in Other Warrants Markets in Asia
- University of California at Los Angeles: The Valuation of Warrants -- Implementing a New Approach
- icapital.biz: Guide to Warrants
- InvestingAnswers: Warrant Premium
- Strictly Business: Stock Options Versus Stock Warrants -– What’s the Difference?
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