Stock Warrants vs. Stock Options: What's the Difference?

Stock Warrants vs. Stock Options: An Overview

A stock warrant gives the holder the right to purchase a company's stock at a specific price and at a specific date. A stock warrant is issued directly by the company concerned; when an investor exercises a stock warrant, the shares that fulfill the obligation are not received from another investor but directly from the company.

An equity stock option, on the other hand, is a contract between two people that gives the holder the right, but not the obligation, to buy or sell a stock at a specific price, prior to a specific date, referred to as the contract expiration date.

Stock Options

Options are purchased by investors when they expect the price of a stock to go up or down (depending on the option type). For example, if a stock currently trades at $40 and an investor believes the price will rise to $50 next month, they could purchase a $40 call option today, which would give them the right to purchase the stock at that price prior to contract expiration.

Then, if the stock does in fact increase to $50 per share, the investor could turn around and sell it for $50, making a profit of $10, less the cost of the option, referred to as the "premium."

Stock Warrants

When an investor exercises a warrant, they purchase stock, and the proceeds are a source of capital for the company. A warrant certificate is issued to the investor when they exercise a warrant. The certificate includes the terms of the warrant, such as the expiry date and the final day it can be exercised.

However, the warrant does not represent immediate ownership of the stock, only the right to purchase the company shares at a particular price in the future. Warrants are not extensively used in the United States, but they are more common in China.

There are two types of warrants: a call warrant and a put warrant. A call warrant is the right to buy shares at a certain price in the future, and a put warrant is the right to sell back shares at a specific price in the future.

Key Differences

It's important to understand the key differences between stock warrants and stock options.

Issuing Party

One key way that warrants and options differ is in who issues them. Options are a contract between two investors. The underlying company is not involved. On the other hand, a company issues its own warrants, and depending on the type of warrant, the company will issue new shares for the transaction.

Standardization of Terms

Options contracts have a largely standardized structure based on the exchange you're using to trade the contracts. Warrants, by contrast, may have non-standard terms or clauses, making it important to read the fine print very carefully.

Dilution

When someone exercises a warrant, the company that issued that warrant must issue new shares to that person. That increases the number of shares that are outstanding and dilutes existing shareholders' stakes in the business.

Options don't involve the issuance of any new shares. Instead, shares change hands between two investors. That does not impact the percentage of the underlying company that any other shareholders own.

Expiration Timelines

Warrants typically have long expiration dates. It's not uncommon for a warrant to expire five, 10, or 15 years from the date it's issued. Options, on the other hand, usually have expiration dates measured in days, weeks, or months. Long-Term Equity Anticipation Securities (LEAPS) are a type of option with longer expiry dates. They can last from one year to up to three years.

Impact on Company

When someone buys or sells an option, their counterparty is another investor. The underlying company does not receive any income when its options get traded.

Because a business issues its own warrants, it gets paid when someone buys that warrant. It also receives payment if the holder exercises the warrant, making warrants an option for companies looking to raise capital.

Key Similarities

Despite some major differences, there are ways in which warrants and options are similar.

Fixed Exercise Price

Both warrants and options give the holder the right to buy or sell shares at a specific price, called the exercise price. That price will remain the same regardless of how the company's stock is currently priced by the market.

Both Expire

Though their expiration timelines are different, with warrants taking far longer to expire than most options, both securities will eventually expire. When that happens, if the holder has not exercised the contract, they lose the option to do so.

In the case of a warrant that is not exercised at expiration, the warrant will become worthless. In the case of an in the money option, it will be automatically exercised at expiration. At the money or near the money options and out of the money options will expire worthless.

No Obligation to Exercise

The holder of an option or a warrant is under no obligation to exercise it and typically will not do so unless there is a financial benefit to doing so. For example, if an investor holds an option to buy shares in company XYZ for $15 each but shares are currently trading at $12, the option holder will likely choose to buy shares on the open market rather than exercising the option.

Impact of Intrinsic and Time Value

The value of both options and warrants is influenced by similar factors.

First is the intrinsic value, which is determined by the difference between the current market value of the underlying share and the exercise or strike price of the contract. If a share is trading at $100 and the strike price of an option is $10, that option will be worth more than if the share was trading at $50.

Both are also influenced by time value. As the expiration date nears, both options and warrants will tend to see their prices fall.

The Bottom Line

Stock warrants and options have some key differences, largely surrounding the issuing party and whether exercising the contract dilutes other owners' share in the company, but also have some key similarities.

Understanding those differences and similarities is important for any investor who is interested in derivatives.