Are Warrants More Desirable Than Options?

03/16/2015 8:00 am EST

Focus: OPTIONS

The staff at Investopedia.com compares and contrasts warrants vs. options, including the benefits, drawbacks, and the risk and reward of each, and they share their viewpoint on why warrants are generally considered a better deal for the issuing company than for investors.

Warrants are typically considered less valuable than options, although they do offer the advantage of having significantly longer expiration periods.

A warrant is a derivative that gives an investor the right to purchase stock for a specified price within a given time frame, one that, unlike most options, may extend out for several years from the date the warrant is issued. Warrants are often offered with the purchase of stock during an initial public offering (IPO) as an additional enticement to buy a company's stock. Warrants differ from options in that they are issued by a company, not traded on an exchange as options are. There are two types of warrants, distinguished by the way in which they can be exercised. An American warrant can be exercised at any time prior to the warrant's expiration date. A European warrant, however, can only be exercised on the date of expiration and is considered less desirable.

Unlike options, there is typically not a 1:1 correspondence between warrants and shares. An investor may, for example, need four warrants to redeem for one share of stock. Warrants are usually issued with strike prices very far away from the current market price, so warrants are usually inexpensive compared to options and offer a potential higher rate of return. However, because most warrants expire worthless, they are also a high-risk investment. Warrants are considered a better deal for the issuing company than for investors, since the company receives payment for a good—stock shares—that it will likely never have to provide.

A warrant is, in effect, a long-term option. Regular exchange-traded options are generally considered a better investment because of the higher probability that they may prove profitable. Warrants are more common in European and Asian markets than they are in the United States.

By the staff at Investopedia.com

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