Warrants

Trading warrants on stocks, currencies and other assets is a popular way of diversifying portfolios. This 101 guide will cover how to trade warrants and the pros and cons of doing so, with detailed examples and strategies to help traders get started. We also list the best brokers with warrants trading in the UK:

What Is A Warrant?

The definition of warrants is similar to options; it is a product that gives investors the option to buy or sell an underlying asset at a pre-set price (the strike price) on or before a predetermined date (the expiry). The main difference between options and warrants is that stock warrants are more typically issued directly by a company. The reason companies may issue warrants is to raise capital for investment.

Warrants are typically traded on the following underlying assets at online brokers:

• Equity Warrants: These give the holder the right to buy or sell shares of stock in a company at a specific price. Equity warrants are a popular choice for online traders who want to speculate on the price movements of individual stocks.
• Index Warrants: These give users the option to buy or sell a basket of stocks that make up an index, such as the FTSE 100 or the S&P 500. Index warrants can be a good choice for trading beginners as they involve speculating on the overall direction of a stock market, as opposed to a single stock.
• Currency Warrants: These give the holder the right to buy or sell a specific currency at a specific exchange rate.
• Commodity Warrants: These allow traders to speculate on the price movements of commodities such as gold, natural gas or oil.

Note that warrants at brokers can come in American style, which can be exercised at any time up to and including the expiry date, and European style, which can only be exercised on expiry.

Two further denominations impact how warrants are traded at brokers; listed and unlisted warrants:

• Listed Warrants: These are traded on a public exchange, such as the London Stock Exchange, and can be bought and sold through a brokerage account that offers access to that exchange. They are also typically issued by financial institutions, such as banks or investment firms, as they fit the stricter regulatory requirements. Listed warrants have standardised terms, so the strike price and expiry are often predetermined and cannot be customised.
• Unlisted Warrants: These are typically bought and sold over the counter (OTC) after being issued by a company directly to investors. These are the type of warrants that are often available to trade at brokers, but they are also offered by a broader selection of entities due to the laxer regulations surrounding them. They are often less liquid and can have customised terms.

Importantly, when warrants are issued by companies, they are subject to dilution. This is where the total number of shares outstanding increases because of the exercise of the warrants. When a warrant is exercised, the holder pays the strike price to the company and in exchange receives a specified number of shares.

The new shares issued in this way can dilute the ownership percentage and voting power of existing shareholders. This is because the new shares are typically issued at a price lower than the current market price of the stock, which can reduce the value of existing shares.

How Does Trading Warrants Work?

To trade warrants in the UK, you will need to open a brokerage account with a broker that offers access to an exchange where warrants are listed, such as IG Index. Once you have opened an account, you can purchase warrants by placing a buy order through your broker.

When purchasing warrants, look at factors such as the strike price, the expiry date, and the type of warrant you are purchasing. If you believe the price of the underlying asset will increase in the future, you can purchase call warrants. If you believe the price of the underlying asset will decrease, you can purchase put warrants.

Once you own the warrants, you can sell them on through your broker to make a profit. If the price of the underlying asset has increased (in the case of call warrants) or decreased (in the case of put warrants), the value of the warrants will increase as well, allowing you to sell them on for a profit.

The buying and selling of the warrants via a broker take place on the secondary market, as you are buying and selling the warrants from other investors rather than directly from the company or financial institution that issued them. In the secondary market, the price of the warrants is determined by supply and demand, and can fluctuate based on a variety of factors, such as the price of the underlying trading asset, market sentiment, and economic conditions.

Example

Let’s say that a private company, XYZ Corp, is preparing to go public through a special purpose acquisition company (SPAC) merger. XYZ Corp has issued warrants as part of the SPAC offering, which gives the holder the right to purchase shares of XYZ Corp at a set trading price within a certain time frame.

The warrants have a strike price of £50 per share and expire in a year. The current market price of XYZ Corp’s shares is £60 per share, and the price of the warrants is £5 each.

An investor believes that the share price of XYZ Corp will continue to rise over the next year, so they decide to invest £1,000 in warrants, which allows them to purchase 200 warrants at a total cost of £1,000.

At the expiry, the share price of XYZ Corp has increased to £75 per share. The investor decides to exercise their warrants and purchases 200 shares of XYZ Corp at the strike price of £50 per share, for a total cost of £10,000 (200 shares x £50 per share). If the investor had purchased 200 shares of XYZ Corp at the market price of £75 per share, they would have had to pay £5,000 more.

The investor can then sell their 200 shares of XYZ Corp at the current market price of £75 per share, making a profit of £25 per share (£5,000), minus the £1,000 spent on warrants or £4,000 in total. In this example, the investor was able to make a higher profit by purchasing warrants instead of shares directly.

However, if the share price falls to £50 per share at the expiry date, the investor would make a loss. If they exercise their warrants and purchase 200 shares of XYZ Corp at the strike price of £50 per share, for a total cost of £10,000 (200 shares x £50 per share), they will only break even. And, they will make a loss of £1,000 on the initial price of the warrants.

Advantages Of Warrants

• Lower Cost: Stock warrants are often cheaper than the underlying trading asset, meaning investors can gain exposure to the asset at a lower price point.
• Leverage: Warrants allow investors to leverage their investments and potentially earn a higher return than they would by investing directly in the underlying asset.
• Diversification: Warrants can be used to diversify investment portfolios.

Disadvantages Of Warrants

• Volatility: Day trading warrants can be volatile and may experience large price swings, which can be difficult for investors to predict and manage.
• Complexity: Warrants are relatively complicated financial instruments that may be difficult for beginners investors to understand.

How To Start Trading Using Warrants

1. Open A Brokerage Account: To start investing in stock warrants, you will need to open an account with an online brokerage. Several brokers in the UK offer warrants. Among the best providers are IG, Trade.com, and Interactive Brokers.
2. Fund Your Account: Once you have opened an account, you will need to deposit funds. Most websites brokers with warrants offer several funding options, including bank transfers, credit/debit cards, and e-wallets.
3. Decide Which Warrants To Trade: Once your account is funded, you can start searching for your preferred type of warrant. You can use the best brokers’ trading platforms to search for warrants or look for them on the London Stock Exchange (LSE) website.
4. Buy The Warrants: When you find a warrant you want to buy, you can place an order with brokers. You can either buy the warrants at the market price or place a limit order at a specific price. Once your order is filled, you will become the owner of the warrants, but not the underlying asset.
5. Monitor Your Warrants: It is important to keep track of the price of your warrants, especially if your warrant is American style – where you can exercise at any point before expiry. Keep in mind that warrants are volatile, so be prepared for sudden price swings.
6. Sell/Exercise: You can either sell the warrant before it expires or exercise it to make a profit. Alternatively, if you see yourself making a loss, you do not have to exercise on expiry; however, you will lose your initial investment.

How To Compare Brokers That Offer Warrants

• Asset Range: Check the range of warrant products available at online brokers. Can you trade equity warrants, currency warrants, and commodity warrants, for example?
• Fees/Charges: Use an online calculator to compare the fees and commissions charged by different brokers for warrant trading. This will include both trading and non-trading fees, such as commissions or currency-conversion fees.
• Platform: Check if the brokers provide a comprehensive platform with real-time data and news feeds. This will allow you to do the required analysis to execute trades and apply your preferred warrant trading strategies.
• Customer Service: The top stock warrant brokers will have 24/7 or 24/5 customer service in case you have any issues or queries. Look for brokers with live chat or phone hotlines as well as email/ticket services.
• Reviews: Check reviews to gauge the reliability and quality of brokers. Alternatively, use our ranking of the best brokers with warrants.
• Regulations: The best brokers with warrants are regulated by the UK Financial Conduct Authority (FCA). UK-licensed brokers will follow customer safeguarding initiatives, such as negative balance protection, alongside robust accounting procedures.
• Extra Features: Look for useful resources like educational webinars, tutorials, and blogs to help you make informed investment decisions. Demo accounts and copy trading available at the best brokers also popular with beginners.

Stock/Index Warrants – Interactive Brokers

UK Taxes Explained

The treatment of warrants for tax purposes is based on how they are acquired. If it is acquired as part of a company share issue, then the cost basis will be the purchase price of the shares. If acquired separately, then their cost basis will be the price of the warrants.

When a warrant is exercised, any gain made on the sale of the underlying shares will typically be subject to capital gains tax. The capital gains tax will be based on the difference between the profits from the sale of the shares and the cost basis of the shares, including any costs associated with the exercise of the warrants.

If the warrant is not exercised and is allowed to expire, then any loss or gain will normally be treated as a capital loss or gain for tax purposes.

Tips For Trading Warrants

• Look for warrants with low outstanding shares, as this can indicate a higher potential for price movement due to lower liquidity.
• Consider the intrinsic value of the warrant compared to its current market price. If the warrant is trading below its intrinsic value, it may be undervalued and a good opportunity to buy.
• Keep an eye on the expiration date of the warrant and the underlying stock’s performance. If the stock is underperforming or the expiration date is approaching, the warrant’s value may decrease.
• Look for warrants with high volume, as this can indicate market interest and liquidity.
• Pay attention to any corporate actions such as rights offerings or dividends, as these can affect the warrant’s value.
• The covered call strategy involves buying shares of the underlying stock and selling call warrants on those shares. This allows investors to earn income from selling the call warrants while still holding onto their shares. This strategy is suitable for investors who believe that the stock’s price will remain relatively stable or only rise slightly.
• The put spread strategy involves buying put warrants with a high strike price and selling put warrants with a lower strike price. This strategy allows investors to limit their potential losses while still benefiting from a fall in the stock’s price.

Bottom Line On Warrants

Warrants gives traders exposure to an asset for a lower price than buying it outright while also trading with leverage. However as with other leveraged derivative products, they can be risky, and some newer traders may find them complex.

Use this guide to understanding trading and investment warrants to get started. Then head to our list of the best brokers with warrants in the UK.

FAQ

Further Reading