Warrants are securitised options and can be regarded as options from the point of view of valuation. They may be issued by the issuer of the underlying, or by a third party. They differ from traded options in a number of ways:
- Warrants are securities, whereas options are (transferable in the case of traded options) contracts. This is a legal difference and not important to investors.
- Warrants are issued by a range of companies and banks, whereas traded options are “issued” by the exchange on which they trade. Warrants issued by a third party (i.e. not the issuer of the underlying and usually a bank) are usually covered warrants. These are the most accessible way for most private investors to buy options.
- The terms of a warrant are decided by the issuer. One effect of this is that some issuers (especially companies issuing call warrants on their own shares) choose very long dates expiries, that may run into many years.
- Warrants are more accessible to investors to buy: private investors can buy them in the same way was shares. They are less accessible to write (i.e. short).
Warrants issued by the issuer of the underlying
Where a call warrant is issued by a listed company on its own shares, it is usual to settle through the issue of new shares at the exercise price.
This means that there is a class of warrants that can cause dilution of earnings and therefore affect the value of the underlying security. This is not usually significant, but some companies have large numbers of warrants or equivalent securities (such as convertible bonds) which would have a significant impact if exercised.
Such warrants are often issued together with bonds or other debt instruments. The effect of this is similar to a convertible bond issue, with the advantage that the option and pure bond elements can be sold separately. If debt holders keep the warrants, they hedge the risks of changes that benefit shareholders at the expense of debt holders. There mere existence of the hedge reduces the incentive shareholders have to do so.