Differences Between Options vs Warrants
- An option OptionOptions are financial contracts which allow the buyer a right, but not an obligation to execute the contract. The right is to buy or sell an asset on a specific date at a specific price which is predetermined at the contract date. is a contract between 2 parties giving the holder the right but not the obligation to buy or sell an Underlying AssetUnderlying AssetUnderlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates. at a pre-decided strike price and a fixed date in the future as well.
- On the other hand, a stock warrant is on similar lines to a stock option since it gives the right to purchase a company’s at a specific price and date. However, a stock warrantStock WarrantA Stock Warrant gives the holder the right to buy the company's stock at a predetermined price in a specific time period, and when the holder exercises the right, the holder buys the company's stock and the company receives the money as its source of capital. is issued by the company itself, and additional new shares are also issued by the firm for the purpose of the transaction.
In this article, we discuss the differences between Options and Warrants in detail.
Options vs. Warrants Infographics
Let us understand the differences between Options vs. Warrants through infographics.
Options vs. Warrants – Similarities
Both Options vs. warrants are treated on similar lines and include the following similarities:
- Both instruments offer the holders an opportunity to enhance their exposure and take advantage of the stock market movements without possession of the asset.
- They confer on their holders the right to purchase a specific quantum of the principal asset at a fixed price and specified date.
- Both represent a right and not any control over the principal asset unless it has been exercised.
- Factors influencing the value of an option or a warrant are the same such as the Underlying stock price, strike price, or the Exercise PriceStrike Price, Or The Exercise PriceExercise price or strike price refers to the price at which the underlying stock is purchased or sold by the persons trading in the options of calls & puts available in the derivative trading. Thus, the exercise price is a term used in the derivative market., Time to expiry, implied volatility VolatilityImplied Volatility refers to the metric that is used in order to know the likelihood of the changes in the prices of the given security as per the point of view of the market. It is calculated by putting the market price of the option in the Black-Scholes model., and risk-free interest rate.
- Both have the same components in terms of pricing, i.e., Intrinsic Value and Time Value of moneyTime Value Of MoneyThe Time Value of Money (TVM) principle states that money received in the present is of higher worth than money received in the future because money received now can be invested and used to generate cash flows to the enterprise in the future in the form of interest or from future investment appreciation and reinvestment.. It is to be noted that.
- Intrinsic value is the difference between the price of the principal stock and the exercise or strike price. This value can be Zero but never negative.
- Time value is the difference between the price of the option/warrant and its intrinsic value.
Options vs. Warrants – Differences
Despite the above, there are the following differences between Options vs. Warrants in detail:
- The option is an agreementOption Is An AgreementThe option agreement is a legally binding contract between two parties, one seller and the other buyer of the option, in which one party has the right but not the obligation to buy or sell the asset and each party's responsibilities to the other, which must be honored until either party exits the agreement. wherein buyers possess the right but not the obligation to buy or sell stock at a specified price and date. Conversely, a warrant is an instrument registered to provide the buyer the right to get a specified number of shares at a pre-decided date and prices.
- Options are standard contracts and are required to adhere to rules governing maturity, duration, size of the contract, and exercise price, whereas warrants are securities (non-standardized), making it flexible.
- Options are issued by the exchange, such as U.S. Chicago Board Options Exchange, whereas warrants get issued by a specific company.
- A stock option is a secondary market instrument as trading takes place between investors, whereas a warrant is a primary market instrument since it is issued by the company itself.
- In options trading, the selling party writes the options while warrants have a single issuer responsible for the rights offered.
- The maturity period also differs with options having until two years and warrants having a maturity of 15 years.
- The underlying assets with respect to options are Domestic shares, bonds, and indices, whereas warrants shall have securities such as Currencies and international shares.
- In terms of making a profit, the company does not receive any direct benefit, which ultimately is passed on to the investor. Conversely, the issue of warrants is to encourage the sale of shares and offer a hedge against fall in the value of the firm, which can lead to a dip in the share price of the company.
- Options do not involve the issuance of new stock, but warrants result in dilution creating issuance of new stock.
- Trading in options involves following principles of a futures market, and warrants follow the principle of cash markets.
- Options can be issued independently, but warrants are combined with other instruments, such as bonds.
- The taxation rules applicable will differ. Stock options are subject to rules governing compensatory items. Warrants, on the other hand, are not compensatory in nature and hence taxable in nature.
- Options can be bought/shorted/written involving multiple trading and hedging strategies, whereas warrants cannot be easily sold. They are largely used by speculators for stock replacement due to possible hedging.
- Margin calls are applicable in options since minimum balance is required for options trading but not so in case of warrants.
Options vs. Warrants (Comparison Table)
|Basis of comparison between Options vs. Warrants||OPTIONS||WARRANTS|
|Meaning||The buyer has the right to buy or sell the underlying asset at a predetermined price and date.||Instrument giving the holder the right to get a specified number of shares at a predetermined price and date.|
|Nature||Standardized Contract||Non-standardized security|
|Underlying Asset||Domestic shares, BondsBondsA bond is financial instrument that denotes the debt owed by the issuer to the bondholder. Issuer is liable to pay the coupon (an interest) on the same. These are also negotiable and the interest can be paid monthly, quarterly, half-yearly or even annually whichever is agreed mutually., and various indices||Currencies and International shares|
|Issuer||Options Exchange||Issued by a specific company|
|Ownership||Employees||Investors, Companies or Partners|
|Terms and Conditions||Set by the equity exchanges||Set by the issuer|
|Type of Products||Equity and Index Calls/Put||Various capital guaranteed investments and other high risk/return trading warrants|
|Lifespan||Equity – till five years and
Index – till 18 months
|Between 3 months – 15 years|
|Dilution||Does not involve the issuance of new stock||Results to dilution|
In a nutshell, both these derivatives are essential for businesses permitting investors to consider investing in the stock without holding the security. The minute details of both instruments need to be studied and accordingly weigh the pros and cons for the same before considering the final decision from a financial perspective. Options can be considered as compensation mediators, whereas warrants are targeted towards aiding the firm in raising capital, debt, or equity securities, and improving the deal for investors. Both instruments have their level of risks, and investors have to carefully understand the derivativesUnderstand The DerivativesDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts. and consider the tax consequences before making use of them.
The risk appetiteRisk AppetiteRisk appetite refers to the amount, rate, or percentage of risk that an individual or organization (as determined by the Board of Directors or management) is willing to accept in exchange for its plan, objectives, and innovation. and long-term financial objective of the investor have to be assessed and maintain caution accordingly. Warrants are highly leveraged and speculative instruments, and hence cautious approach should be taken, and in contrast, options involve less risk with high growth potential with a limited capital requirement.
This has been a guide to the top differences between Options vs. Warrants. Here we also discuss the Options and Warrants with examples, infographics, and comparison tables. You may also have a look at the following articles for gaining further knowledge in Derivatives –