The derivative market has been one of the most preferred alternatives to stocks by investors. The derivative market consists of number of investment instruments ranging from options to warrants. Today, we will discuss about stock warrants and find out how it can be a great alternative to conventional stocks.
Stock warrants are a type of derivative contract which provides the warrant holder with a right to buy the stock of a particular company at a pre-defined price after a certain period or on a particular date. The working of warrant may sound similar to that of stock options, but there are major differences between the two. The differences are based on the working mechanism, accessibility and taxation on these instruments.
Stock warrants are issued by the companies for raising capital, benefits of employees or as a employee retention or recruitment package. Let us now discuss about warrants in detail and find out how you can benefit from investing in them.
What is a stock warrant?
Stock warrants are a type of derivative contract, who entitle the warrant holder with a right to buy the shares of that particular company at a pre-defined price on a certain date. The pre-defined price is known as the strike price whereas the date is referred to as the expiry date.
Stock warrants can be further classified into two types – call warrant and sell warrant. The call warrant allows the investors to buy the shares whereas a sell warrant allows the investor to sell the shares. As a warrant holder, the investor does not require to process these transactions. However, they do have the right to do so if they want.
The warrant can be used on or before the expiry date, but once the warrant has expired, it cannot be used. While, in certain countries, the warrant holder can utilize his right only on the specified day, while in some countries it can be exercised any time before its expiry.
Examples of Stock Warrants
Let’s say, a company ABC limited, issues stock warrants to its newly hired employees. The warrant could be structured as American style call warrant for 10,000 shares of ABC limited stock at $70 within five years.
In the above scenario, the warrant holder has the right to buy up to 10,000 shares of ABC limited for $70 per share. Now, even if the stock is trading at $100 per share, the warrant holder has the right to buy it at $70 per share. The higher the price of the stock, the more will be the value of the warrant. Now, the warrant holder can utilize the warrant anytime before 5 years. After the expiry, the warrant will become useless.
Taxes on Stock Warrants
There is huge difference between the taxation on stocks and stock warrants. If you plan to utilize a stock warrant you will be entitled for taxable income which will amount to the difference of the strike price and the current share price. The income from warrants is deemed as ordinary income and not capital gain because you don’t actually own the stocks before exercising the warrant.
Warrants are a great alternative to stocks. Since they allow you to buy or sell a stock at a future date on a pre-defined price, they offer lot of versatility. However, investing in warrants is very different from trading in stocks and require experience. You can get warrant trading recommendations form an investment advisor and enhance your trading experience.
