Warrant

A warrant is a securitized derivative. It gives the buyer the right, but not the obligation, to trade a specific underlying asset – such as a stock or a currency – at a predetermined price.

Depending on their structure, warrants are classified as call warrants (right to buy) or put warrants (right to sell), and they can be exercised either within a specific time period or at a fixed point in time. Warrants are typically issued by banks and actively traded on exchanges such as the SIX Swiss Exchange.

Although warrants and options function similarly from a mathematical standpoint, they differ fundamentally in legal and structural terms. While options are standardized contracts traded on a derivatives exchange, warrants are customized, securitized financial products whose terms are freely determined by the issuers. However, this structure entails a significant counterparty risk: Since you hold a security issued by a specific bank, you bear that bank’s credit risk. If the issuer goes bankrupt, the warrant may become worthless – even if the investor’s actual market assessment was spot on.

Investors use these instruments primarily for their leverage effect, as they allow one to participate disproportionately in the price movements of the underlying asset with a relatively small capital investment. However, this leverage also entails correspondingly high risks.

If the price of an underlying asset falls below the strike price, a call warrant loses its intrinsic value – and the opposite is true for a put warrant. The second important component is the time value, which declines on a declining balance basis toward the end of the term. After the expiration date, every warrant is worthless. This results in a total loss of the capital invested, unless the warrant could be sold beforehand.