Let’s take this gently…
Definition
It’s a good idea to treat the process of warrant definition as a glass of fine wine. Swallowing the whole lot in one great gulp can make you dizzy. It is better to sip. There is a lot to savour. Not only are warrants composed of a number of elements, but those elements vary markedly between differing forms of warrants, of which there is a broad array. And just as different wines are suitable for different drinkers, different tables, and different budgets, covered warrants offer equal diversity. There are:
More simply, then,
a warrant is a right to buy or sell an asset at a fixed price, on or before a specified future date.
Warrants are similar to options. They present opportunities for capital gains which make them an attractive medium for speculative investing, although they can be used to serve a variety of aims.
The attraction of warrants
As mentioned already, there are many different types of warrants, but the common theme is that they enable investors to obtain exposure to the performance of the asset for a fraction of the price. This is called gearing. Instead of paying 100p for a share, warrants might provide the same profit potential for 20p, and this lower price means that their percentage gains (or losses) are greater. Gearing means that you get more bang for your buck.
Example
As always, the best way to describe covered warrants is by way of an example -
| Example of a call warrant | |
| A call warrant carries the right to buy one share at | 110p |
| Current share price | 100p |
| Current warrant price | 5p |
| If the share price rises to | 130p (+30%) |
| the warrant would rise to at least | 20p (+300%) |
In the above case, a 30% increase in the share, results in a 300% increase in the warrant – this is the effect of gearing.
And an advantage of covered warrants over traditional UK warrants, is that money can be made in a falling market by buying put warrants. Another example -
| Example of a put warrant | |
| A put warrant carries the right to sell one share at | 90p |
| Current share price | 100p |
| Current warrant price | 5p |
| If the share price falls to | 60p (-40%) |
| the warrant would rise to | 30p (+500%) |
Note: We've highlighted above the main attraction of warrants, which is the gearing effect on performance. Remember, though, this gearing works both ways: it propels warrant prices up quickly, and can do the same driving them down.
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