A stock warrant is a financial instrument that acts as an agreement between the company that issues the warrant and the investor that buys it. The warrant gives the investor the right to buy or sell a certain number of shares from the company at a certain price before an expiration date. This is not an obligation to buy or sell the shares, though.
If the investor decides to buy the shares, they exercise the warrant. Until then, the investor doesn’t own any shares, can’t vote as a shareholder and can’t collect dividends from the company.
Fun fact: “American-style” warrants can be exercised anytime before the expiration date, while “European-style” warrants can only be exercised on the expiration date.
A stock warrant allows the holder to buy shares of a company’s stock at a set price — a discount to the market price — before the expiration date. They are bought and sold through stock brokers, but not listed like stocks.
Suppose Company X wants to raise capital. It offers warrants to give investors the right to buy company shares at $10 per share within the next four years. Currently, the company’s shares trade at $7 per share.
If the investor believes the company will be worth more than $10 in the next four years, they buy the right to purchase 1,000 shares at $10 per share. To buy the warrant, the investor pays $0.50 per share, or $500 total for the 1,000 shares.
Four years later, Company X trades at $25 per share. The investor decides to exercise the warrant and buy the 1,000 shares at the agreed price of $10. The investor pays $10,000 to buy the shares for a total cost of $10,500 ($10,000 for the shares plus $500 to buy the warrants four years ago). The investor can now sell the shares at the market price of $25, or $25,000 total, and pocket $14,500 profit.
Alternative scenario: Four years later, Company X trades at $5 per share. The investor would not exercise the warrant and will only lose the initial $500 paid to buy the warrant. The investor could also sell the warrants to someone else before the expiration date.
Companies issue warrants to raise capital or make their bonds more attractive. Sometimes a bond may have a warrant attached to it, but it will pay less interest than a bond without a warrant. In this case, investors who want to earn more on interest and don’t want to buy the company shares can opt in to buy bonds without warrants.
By issuing warrants, the company profits in two main ways:
There are four types of warrants that slightly differ in one aspect: whether you have to buy bonds or preferred stock along with the warrants.
| Warrant type | Definition |
|---|---|
| Traditional | This type of warrant is offered as a detached part of a bond or preferred stock. The investor can “detach” the warrant and sell it individually while keeping the bonds or preferred stock. |
| Wedded | Wedded warrants are attached to a bond. You can’t “detach” the warrant and sell it individually; you have to sell both. |
| Covered | Covered warrants are those bought by a financial institution from the issuing company. The financial institution can then sell the warrants to investors. |
| Naked | The most basic type of warrant without any attachments like bonds or preferred stock deals. |
You can buy two types of warrants: call warrants and put warrants.
Stock warrants are similar to stock options in the sense that they both give you the right but not the obligation to buy or sell shares of stock. But there are differences.
| Stock warrants | Stock options |
|---|---|
| Issued by the company over the counter | Traded between investors on an exchange |
| New shares are issued and can cause dilution if warrants are exercised | Existing shares are traded and there is no dilution |
| Used for companies to raise capital | Doesn’t affect the company |
| Expiry date up to 15 years in the future | Typically last for a few months |
Stock warrants are considered taxable income at the amount of the difference between the exercise price and the price of a share when you exercise the warrant, minus the cost basis. Here’s an example:
Capital gains and losses
You have two options:
If you hold the stock, the exercise price becomes your cost basis. Gains or losses from that price onward are considered a capital gain or loss. Shares you hold for more than a year after exercise is considered a long-term gain or loss.
Buying stock warrants can be useful, but there are drawbacks to consider.
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Stock warrants can be a decent investment option if you believe in the company that offers them. This can give you the option to purchase shares at a lower price than what it could trade in the future. But be sure to do your research to determine whether they’re right for you. Paid non-client promotion. Finder does not invest money with providers on this page. If a brand is a referral partner, we're paid when you click or tap through to, open an account with or provide your contact information to the provider. Partnerships are not a recommendation for you to invest with any one company. Learn more about how we make money. Finder is not an advisor or brokerage service. Information on this page is for educational purposes only and not a recommendation to invest with any one company, trade specific stocks or fund specific investments. All editorial opinions are our own.
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