A share warrant essentially offers UK investors a risky but potentially very lucrative investment opportunity if the underlying stock rises in value.
It goes without saying that before investing in share warrants, investors should take into account how much risk/leverage they’re prepared to accept, what their time frame is and how much they can afford to lose.
We will now look at what a share warrant is in more detail, why companies issue them and the pros and cons of investing in share warrants as an investor in the UK.
What is a share warrant?
A share warrant, also known as an equity warrant, essentially gives a shareholder the right to buy a company’s shares at a particular time in the future, at a price which is set in the present, known as the exercise price.
Most warrants have terms of between 2 and 10 years, depending on the nature and circumstances of the deal. Typically, the longer the term, the more valuable the warrant is, since it provides more opportunity for a significant payout if the company has a successful exit or the stock otherwise appreciates in value.
Types of share warrants
There are two types of share warrant:
- CALL – a covered warrant that gives the holder the right, but not the obligation, to buy the underlying at a future date and specified price.
- PUT – a covered warrant that gives the holder the right, but not the obligation, to sell the underlying at a future date and specified price.
Examples of a share warrant
The range of securities traded as warrants has increased over the years, and may, nowadays, include shares, share price indices, currencies, commodities etc. Unlike options, however, warrants are issued by companies, banks and governments, rather than stock exchanges, but are, nevertheless, traded in many key financial markets across the world.
Warren Buffet’s Berkshire Hathaway
In 2017, Warren Buffet’s Berkshire Hathaway Inc. exercised warrants to buy 700 million shares of Bank of America stock. This move made Berkshire Hathaway the largest shareholder in Bank of America. It received the warrants when it bought preferred stock.
Berkshire Hathaway’s warrants had an exercise price of $7.14 per share. At the time, Bank of America’s shares were trading for $24.32, which means this move was immediately profitable. Berkshire Hathaway was able to buy stock worth $24.32 for $7.14.
How does a share warrant work?
Warrants are usually of one or two types, investment, or trading. The simplest type of warrant grants the right to buy, or sell, an individual stock, or index, but warrants on commodities, such as crude oil, and currencies, allowing investors to take a position on exchange rates, for example, are other possibilities. Sometimes more than one type of warrant can be used to achieve the same investment objective.
Index warrants are often the most actively traded type of warrant on overseas markets, not least because the primary market indices – FTSE 100, Dow Jones, Nikkei 225, etc. – are closely monitored, allowing investors to make informed judgements.
Why do companies issue warrants?
Companies will issue stock warrants for a wide variety of reasons including raising capital and as an employee perk.
How is the value of a share warrant calculated?
The value of share warrants can be calculated as follows:
1. Find out the exercise price
You need to know this in order to calculate the value of the warrants. Exercise prices are generally set well above the stock’s market price at the time of issue. For example, if the stock is selling for £25 per share when the warrants are issued, the exercise price might be £40 or more.
2. Find the conversion ratio (gearing ratio)
This is usually in the terms and conditions of the warrants. Generally, you need more than one warrant to buy one share of stock. For example, the company might require five warrants to purchase one share of stock at the exercise price. So, in this example, the conversion ratio is 5-to-1.
3. Look up the current market price of the stock
You need to subtract the exercise price from the market price to find the intrinsic value of the warrant.
Example of a share warrant calculation
For example, say the market price is £50 per share and the exercise price is £40, it gives you an intrinsic value of £10 per share. Divide the intrinsic value by the conversion ratio to find the value of one warrant.
In this example, if the conversion ratio equals five, you have £10 divided by five. One warrant is thus worth £2. If the market price is less than the exercise price, the warrants have no value because you could buy the shares on the market for less.
Warrants acquire value only if the market price rises above the exercise price.
Download the free ebook now
Enter your email to receive my free “How to Make 6 Figures in Stocks” ebook with everything you need to start investing in UK stocks.
Are share warrants good or bad?
The advantages of share warrants are as follows:-
- The holder can buy and sell the securities and shares in the market.
- Warrant prices are low so the leverage and the gearing which it provides is high.
- Due to these prices, there are larger capital gains and losses.
- They can offer gains and protection in the market.
The disadvantages of share warrants are as follows:-
- The high price of leverage and gearing of warrants means investors have to take more losses then gains as the percentage of loss of the warrant increases.
- The certificate value can drop to zero so the warrant may lose the redemption value.
- The holder has no rights and is affected by the decisions made by the company.
How to use stock warrants
A warrant gives the holder the right, but not the obligation, to buy or sell an underlying equity, or index, at a specified price (the strike price), on or before a specified date. They offer private investors the opportunity to benefit from falling as well as rising markets;
What is a Call Warrant & Put Warrant?
If you believe the price of the underlying security is going to rise then you would buy a ‘Call’ warrant,
Alternatively, if you believe the underlying price is going to fall then you would buy a ‘Put’ warrant.
They also offer the potential to protect existing portfolios against adverse movements in the market and the possibility of higher returns through gearing.
What happens if a share warrant expires?
If you do nothing with the warrants and let them expire, they become worthless. Depending on the price specified in the warrant and the current trading price, it may or may not be worth it to “exercise” the warrants, which means to actually do the trade that the warrants give you the option to do.
Should I buy share warrants?
Share Warrants carry very few rights. Holders are not entitled to any dividends and have no voting rights. In addition, if you don’t exercise your subscription right by the expiry date then your warrants will expire and you could lose what you paid for them.
How do I buy share warrants?
You can buy them in the same way as any other quoted security. You will receive a certificate (which will set out the terms in which you can exercise your subscription rights) or they can be held within a Nominee or an ISA. Warrants can be issued as a bonus to shareholders or as an incentive to encourage shareholders to partake in a rights issue or open offer. Because of the gearing, warrants are very speculative; therefore a Complex Instruments: Appropriateness Assessment Form must be understood and completed before dealing.
How are share warrants taxed?
In the UK, Stamp duty will normally be due on the transfer of the warrant since an instrument of transfer will usually have to be completed and executed where the legal and beneficial rights to the warrant earlier registered in the legal name of the seller are acquired by the new purchaser of the warrant.
However, when the warrant is exercised, there is no stamp duty due on the issue of the new shares to which the warrant refers.
Share warrants: Final thoughts
In conclusion, for long-term investments, stock warrants may be a better investment than stock options because of their longer terms.
As an investor, this will give you time to gauge how market movements may affect stock pricing so you can decide when the best time to exercise a call or put warrant might be.