Differences Between Warrants & Options
Options contracts are fundamentally different from most other financial instruments, and yet many people do still get options trading confused with other forms of trading such as forex trading or stock trading. It's good advice for anyone that has any interest in trading or investing to really understand the various financial instruments that can be bought and sold and how they differ from each other.
Of all the financial instruments that can be traded on exchanges and markets around the world, it's actually warrants that are the most similar to options. On this page we provide information on how warrants work, and how they are different from options. We also look at some of the advantages that we believe options offer.
Major Differences Between the Two
Warrants and options are very similar and they are often considered to be essentially the same thing but just with a different name just like stocks and shares are basically the same. However, there are differences between the two and it's important that you recognize these differences and what they mean for the investor. Although they share a lot of the same characteristics, there a couple of key aspects of warrants that make them quite distinct from options.
The definition of an options contract can be simplified as follows: a financial contract that grants the holder the right, but not the obligation, to either buy or sell an underlying security at an agreed price by an expiration date. These contracts can be classified as either calls, which give the holder the right to buy the underlying security, or puts which give the holder the right to sell the underlying security.
They can also be either American style where the holder can exercise their right to buy or sell the underlying security at any time up to and including the expiration date, or European style which can only be exercised on the expiration date.
In their typical form, warrants are very similar to European style call options, in that they give the holder the right to buy an underlying security at a fixed price on a fixed expiration date. However, options contracts are typically written by either private investors or market makers, and the underlying security can be a wide variety of financial instruments. Warrants, however, are written by companies with the underlying security being stock in the issuing company.
For example, Company X would write warrants based on the underlying security of a Company X stock. Warrants can be American style too, but call warrants of a European style are the most common. If the holder of a warrant wants to sell it, it is sold back to the issuing company rather than to another trader or investor.
So although the basic principle of the two financial instruments is very similar, there is a very significant difference in terms of who is writing the contract. While most options follow a certain standardized framework, warrants are essentially customized precisely to suit the issuing company and what they are trying to achieve.
For example, while the length of options are measured in months, warrants can be, and often are, measured in years and tend to have a much longer life span. Because of the fact that they are highly customized, warrants are typically traded in over the counter markets rather than the publically traded exchanges.
Warrants are issued by companies for a variety of reasons; they are often attached to bonds in order to make the bonds a more attractive option for investors. They can also be attached to preferred stock and can even be used in private equity deals. One of the other main differences is that exercised options based on stock involve the sale and purchase of existing stock, while exercised call warrants result in the company issuing new shares of stock.
Advantages of Options Over Warrants
Despite the similarities between the two instruments, the differences that exist lend certain advantages to using options in a trading strategy rather than warrants. One of the biggest reasons to trade options is the ability to create spreads, which can be used for many different purposes. These spreads can be created in a number of ways, but they typically involve simultaneously buying and writing options contracts.
While warrants can still represent a solid investment in their own right, there are significantly less trading strategies that can be used involving warrants than those involving options. Also, as they are generally traded over the counter, they are not as easy to buy and sell as options contracts. They are largely traded on the exchanges and therefore much more accessible.
Because warrants are written only by companies whose own stock is the underlying security, or by a financial institution representing that company, it's not possible to take a short position on them and make money from the stock going down in value. This reduces the number of potential opportunities for making profit compared to options which can be used to profit from stock and other financial instruments going down in value as well as up.
In summary, buying warrants can certainly be a good idea in the right circumstances but options offer greater accessibility and versatility to traders.