Traditional corporate equity warrants

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2. What is a warrant?

There are a few different types of warrants, but in this course we'll be talking mainly about call warrants issued by UK companies.

In technical jargon, equity warrants are transferable option certificates issued by companies and trusts which entitle the holder to buy a specific number of shares in that company at a specific price at a specific time in the future.

Similar to options

If your eyes glazed over reading that last sentence, don't worry. Basically, warrants are similar to long-term options.

Like options they offer the opportunity of capital gain, which can make them interesting for speculative investing. Like options, again, the price movement of warrants tends to reflect the price changes in the underlying equity - but in an exaggerated fashion. For example, if the price of a share increases 10%, the price of an associated warrant may increase 30%. That is the bottom-line attraction for speculators.

But warrants are not exactly like options; there are a few differences, which are summarised in the table below.

Differences between warrants and options

Although some of the differences listed above are important in certain cases (for example, the issue of new shares upon warrant exercise will have an effect on calculations of a company's earnings per share), the majority of warrant investors need not concern themselves unduly by them. From the viewpoint of analysis and valuation for speculative purposes, warrants can be considered like options.

Risk scale

Because warrants exaggerate the movements of the underlying equity, they tend to be more volatile than shares. As such, they are considered higher risk. On a scale of increasing risk, warrants would be placed more risky than shares, but below future and options.

Summary

Warrants are like long-term options. They are attractive to speculators because they exaggerate the movements of the underlying equity - if the share moves up a bit, the associated warrants can increase a lot!

1. Introduction 2. What is a warrant? 3. The warrant market 4. Advantages of warrants over shares - the magic of gearing 5. Further attractions of warrants 6. Disadvantages of warrants 7. Fundamentals - warrant terms 8. Fundamentals - intrinsic value and parity ratio 9. Basic analysis 10. Analysis - time value and premium 11. Analysis - gearing 12. Analysis - break-even and capital fulcrum point 13. Analysis -sample spreadsheets 14. Analysis - summary 15. Investing strategies 16. Dealing in warrants 17. Warrant exercise 18. Further topics 19. Further information 20. Conclusion

• Andrew McHattie on Covered Warrants