Options and warrants are two derivatives traded in the exchange that give an option to the investor to buy the stock at a predetermined price and date. The basic difference between options and warrants is that while options are contracts, but warrants are financial instruments.
Derivative connotes a financial instrument with no independent value, in essence, the value is ascertained from the value of the underlying asset, such as commodities, currencies, livestock, securities, bullion, etc. In finer terms, derivatives represent forward, futures, options, swaps and warrants.
This article explains you the meaning and concept of the two types of derivatives and also makes a comparison between options and warrants, so take a read.
Content: Options Vs Warrants
|Basis for Comparison||Options||Warrants|
|Meaning||Option is believed to be a privilege that confers the buyer the right, not the obligation to buy or sell the stock at the specified price on a certain date.||Warrants refers to an instrument registered and traded separately, which gives the holder the right to get specified number of shares at a predetermined price and date.|
|What is it?||Contract||Security|
|Instrument||Secondary market instrument||Primary market instrument|
|Trading||Between investors||Warrants are issued by company or financial institution.|
|Exercise||On the exercise of option one investor gives or receives shares to/from another investor.||On the exercise of warrant shares which meet out the obligations are received directly from the company.|
|Underlying asset||Bonds, indices and domestic shares.||Currencies, international shares.|
Definition of Options
Options imply the fundamental category of derivative securities. A contract between two parties, in which one party acquires the right, but not the obligation to purchase or sell the underlying asset, at an agreed price, on or before the specified date.
The party obtaining the right to buy or sell the security is considered an option buyer, while the party conferring such right is termed as option seller. An adequate consideration is charged by the option writer (seller) from the option holder (buyer) called an option premium. The underlying asset is the financial instrument or commodity covered under the contract, which can be shares, foreign currencies, bonds, futures contract and so forth. The agreed price is called as the strike price or exercise price and the date on which the contract expires is known as maturity date.
There are two styles of options, i.e. American option, which can be exercised anytime before its expiry, and a European option, which is exercised on the date of its maturity.
Classification of options:
- Call option: It gives the recipient the right to buy an asset at a predetermined price and date.
- Put option: It gives the recipient the right to sell an asset at a fixed price and date.
Definition of Warrants
Warrants are also one of the important financial instrument traded in the market. Similarly like an option, it also gives the holder, the right to subscribe to a stated number of equity shares of a particular entity, at an agreed-upon price, during a specified period. The registration and trading of warrants are separately done in stock exchange.
On the exercise of the right by warrant holder, the number of shares of the issuing company is increased, resulting in the dilution of equities of its shareholders. These are normally issued by companies to ‘sweeten’ debt issues, such as debentures and bonds. Warrants are attached to a security premium note, so as to attract investors. However, it can be detached and issued independently.
Key Differences Between Options and Warrants
The difference between options and warrants can be drawn clearly on the following grounds:
- The option is the agreement between parties, wherein buyer possesses the right, not the obligation to buy or sell the stock at the specified price on a certain date. An instrument registered and traded separately, which gives the buyer the right to get specified number of shares at a predetermined price and date, is called as warrant
- While options are contracts, warrants are securities.
- Options are highly standardised, in essence, they need to adhere to the rules concerning the maturity, duration, size of the contract, exercise price and trading unit, however, warrants are flexible in nature.
- A stock option is a secondary market instrument, as the trading takes place between investors. Unlike an option, a stock warrant is a primary market instrument, as the company itself issued warrants.
- In the case of a stock option, the trading is performed between investors. But stock warrants are issued by the company or financial institution.
- When the stock option is exercised, one investor gives or receives shares to/from another investor. On the contrary, when the warrant is exercised, shares which meet out the obligations are received directly from the company.
- The underlying tradable asset for options is bonds, indices and domestic shares. Conversely, the underlying tradable asset for warrants are currencies, international shares.
By and large, both the financial derivatives are essential tools for business, that allows the investor to invest in stock, without holding the security. One has to be very cautious while dealing with warrants as these are highly speculative and leveraged instruments. In contrast, investing in option, involves less risk, high growth potential, with the limited capital requirement.