Fundamentals of using warrants in the stock market

Fundamentals of using warrants in the stock market

Introduction to Warrants

If you have traded on Forex, you may be familiar with options. These derivatives are used for hedging, as you can buy or sell a currency pair at a fixed price and date. Warrants are similar instruments that circulate in the stock market. They allow you to limit risks and secure the best prices. Here is an overview of the instrument.

In India, traders can use a wide range of financial tools. Stocks can be bought and sold through global brokers. You can profit from the performance of the largest world corporations. All you need is a live trading account, dedicated software, and brokerage services. Derivatives like warrants are linked to stocks. 

Definition of a Warrant

The instrument is defined as a derivative security contract. Its holder essentially buys the right to purchase or sell the underlying stock at a certain price. This fixed price is also known as the exercise price. A warrant has an expiry date, and you can trade the stock at any time before it.

Warrants Linked to Individual Stock

This subtype entitles you to buy or sell  stock of a certain company. The amount depends on a special multiplier. For instance, if it equals 1, you can purchase or sell a single share per warrant. If it equals 0.01, you need 100 warrants to buy or sell one share.

Therefore, to see how many derivatives you need, divide the desired number of shares by the value of the indicator. Consider this example. How many call warrants allow you to buy 100 shares if their multiplier is 0.1? Divide 100 by 0.1. Thus, you need 1,000 warrants.

Warrants Linked to a Stock Index

An index reflects the performance of a group of companies, rather than a single corporation. It is therefore diversified by nature and very unlikely to ever fall to zero. If you do not want to rely on a single company, indexes are an attractive alternative. For instance, the S&P 500 is measured based on stocks of the 500 largest U.S. corporations.

So, what does such a warrant give? The holder may buy or sell the index. Some schemes imply that the underlying asset is never actually traded. In some cases, it is impossible to trade the index directly. In these situations, warrants are settled in cash.

Overview of Similarities

In terms of trading logic, warrants and options are similar. They also use the same terms, such as strike price. The holder of a warrant has the right (not an obligation) to buy or sell the underlying stock. This can be done at any time before expiry.

Warrants themselves can be sold before or at their expiration date, depending on the country. It is always best to consult your brokerage firm before purchasing these derivatives. If you haven't traded stock before, consider opening a demo account first. Brokers like Forextime provide Forex copy trading services in India. These can help you make money in different financial markets.

Both options and warrants give you the right to buy (call options and call warrants) or sell (put options and put warrants) the underlying instrument on fixed conditions. In essence, their holders bet on the direction of the market.

Both derivatives can be in profit or loss depending on the accuracy of the holder's prediction. Everything depends on how the market moves relative to the strike price.

Overview of Differences

Still, these instruments are not identical. The key distinction between warrants and options is their source. The former are issued by the organization (financial institution or business) whose stock you purchase. The latter, on the other hand, are issued by the market. Other specific features of warrants are:

  • lower premiums,
  • higher leverage,
  • higher volatility, and
  • higher risk.

Warrant Specifications Vary

Generally, these are similar to specifications for options. However, not all warrants are identical. Even within the same market, different warrants may be based on different terms. The elements that often vary are:

  • the expiration date,
  • the multiplier, and
  • lowest trading size accepted (e.g. 100 warrants).

Be Careful With Warrants

As derivatives, warrants share some of their features with options. A warrant may give you the right to buy or sell a stock or a stock index. Due to their highly leveraged nature, they are seen as a high-risk instrument. Today, they can be bought and sold online.

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