Stock Warrants: Origin, Purpose and Key Differences from Options

Stock warrants and stock options are both financial contracts between two parties. An investor can use them to generate profit in an investment portfolio. Both warrants and options enable the holder to purchase or sell a company’s stock at a given price and on a given date. Although they have a number of similarities, warrants and options differ from each other in fundamental ways. The primary distinctions are in how they originate, their respective lifespans, and the purpose of issuance.

Differences Between Stock Warrants and Options

A warrant is a type of long-term security that provides the holder with the right, but not the obligation, to buy a company’s stock at a predetermined price on a predetermined time in the future. The price at which a holder is allowed to purchase the common shares of the corporation is called the exercise price. Once the expiration date occurs, the warrant will no longer be exercisable. Warrants are often issued as a reward to loyal investors to enable them to potentially buy the company’s stock down the road at an agreed-upon exercise price. By purchasing the stock at a point when the exercise price is lower than the price that the stock is trading, the stock warrant recipient will make an immediate profit.

Distinct Features of Stock Warrants and Options

Despite the fundamental similarities in these financial instruments, warrants and options have a number of distinct qualities. Warrants are issued by the company whose stock underlies the warrant. Trading takes place in the over-the-counter market, individual trade directly among themselves. In contrast, third parties issue options. The third party is most often an exchange such as the NYSE or NASDAQ.

Stock Warrants Options
Stock Warrants Options

Differences in Corporate Purposes for Issuance

There are differences in the corporate purpose behind the issuance of warrants and options. Companies issue warrants for the purpose of raising capital for the company. They have longer durations in order to attract investors by giving them the warrants as a reward for providing a longer-term investment in the company. Companies use options to incentivize strong employee performance.

The Variety of Stock Warrants

A number of different types of warrants exist. These categories include traditional warrants, naked warrants, and covered warrants. Traditional warrants are issued accompanied by bonds or preferred stock. This is a better for the buyer because they can sell the warrants without selling the attached bond or preferred stock. Participants sometimes call traditional warrants detachable warrants for this reason. The key factor that differentiates naked warrants from traditional warrants is that naked warrants are issued on their own, not in conjunction with bonds or preferred stock. For this reason, participants sometimes refer to naked warrants as non-detachable warrants or wedded warrants. Financial institutions issue covered warrants, not the company itself. The warrants are “covered” by the issuing institution, which owns or can easily obtain the underlying shares. The implication is that no new issuance of common stock occurs when a covered warrant is exercised.

An Example of Restructuring from the 1980s

An example illustrating the value of stock warrants in the restructuring context is that of Chrysler in the early 1980s. Chrysler issued 14.4 million warrants to the government when the company was near bankruptcy. The purpose of the warrant issue was to attract investors. However, this issuance ended up being disastrous for Chrysler. The company issued the warrants at an exercise price of $13 per share when the stock price was only $5. Unexpectedly, Chrysler’s stock price later climbed to $30 per share, requiring the company to pay $311 million to the government for all the stock warrants sold.

Ryan Carpenter serves as Attorney and Managing Director of Carpenter Wellington. Ryan advises clients across a broad set of corporate and commercial matters.

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store