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What Is a Trading Warrant?
Trading Warrants are securitised warrants that can be traded on a Stock Exchange.
There are two types of trading
warrants:
- Call Warrants
- Put Warrants
Let's assume you want to invest in the mining industry. The "Gold Nugget" mining company looks like a thriving business. As an astute investor, you don't want to miss out on this opportunity. Shares in Gold Nugget are currently $10, which you hope will quickly appreciate to, for example, $15. This would give you a profit of $5. If you are wrong and the share price falls to $7, you would lose $3.
Rather than taking the risk of buying the shares directly, you can buy a share through a Call Warrant on the Gold Nugget share. This may cost $0.80 and gives you the right to buy the share for a predetermined warrant term, at the fixed price of $10.
If the Gold Nugget share does go up to $15 the warrant would be worth at least $5, because the warrant allows you to buy the share for $10 and immediately sell it again for $15. Rather than actually buying and selling the share, however, you would simply sell the warrant itself for $5. After deducting the purchase price of $0.80, you end up with a profit of $4.20.
The down side of a call warrant is if the share price falls. If this occurs the warrant is effectively worthless because no one would pay $0.80 for a warrant with a $10.00 strike price, when the share itself can be bought in the market for $7. If you predict that the share is not going to move upwards, the best strategy is to sell the warrant as soon as possible before expiry, in order to limit any losses. In any case, you cannot lose more than the $0.80 warrant that you paid in the first place for the warrant. When you buy a warrant, you know from the very beginning what your maximum possible loss could be.
Using the same example, a put warrant would entitle you to sell one Gold Nugget share for $10. Let's say the put warrant costs $0.60. If the Gold Nugget share price plummets to $6.00, the put warrants will be worth at least $4 because you can now buy a share for $6 and immediately sell it again, using the warrants for $10. The difference of $4 is your profit, less the initial purchase price of $0.60.
Similar to call warrants, if the price went up to $12, the warrant would be worthless because investors could sell the share for $12 in the market, while your warrants is only worth $10. Again, the best strategy if you predict that the price will not go back down before the expiry of your put warrant is to sell your warrants as soon possible. Your risk is always limited to the price you paid for the warrant in the first place, in this case $0.60
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