How to buy stock warrants

The Bottom Line

Warrants can offer a useful addition to a traditional portfolio, but investors need to be attentive to market movements due to their risky nature. Even so, this largely unused investment alternative offers the opportunity to diversify without competing with the largest market players.

Warrants are long-term instruments that also allow shareholders to purchase additional shares of stock at a discounted price, but they are typically issued with an exercise price above the current market price. Both rights and warrants conceptually resemble publicly traded call options in some respects.

A stock warrant represents the right to purchase a company’s stock at a specific price and at a specific date. A stock warrant is issued directly by a company to an investor. Stock options are purchased when it is believed the price of a stock will go up or down. A stock warrant represents future capital for a company.

Learn what units, warrants and shares are.

While you can buy SPACs on brokerage platforms like Robinhood, what you‘re actually buying is a little different than a normal stock. Instead of purchasing shares in a company, you‘re buying either a unit, SPAC share or warrant.

For example, if over the next year the stock rises to $80, the warrant has become more valuable. The stock is trading at $80 and the warrant holder has the right to buy at $40 (and could immediately sell those shares for $80).

Warrants tend to be a high risk, high reward investment. If you’re able to exercise your warrant for a profit, you would likely call them ‘good‘. On the other hand, there’s a risk of a warrant expiring without being in the money.

The main difference between a stock option and a stock warrant is how they originate – warrants are issued by the company itself whereas stock options are listed on an exchange. A company can raise capital through issuing warrants, whereas it doesn’t make any money from transactions in which stocks are exchanged.

Stock Warrants Defined

It gives the individual the right to trade that company’s shares at a certain price on or before a certain date. The price is known as the “strike price,” while the date is known as the “expiration date.” After the expiration date, the warrant has expired, and the holder can no longer use it.

When you exercise warrants to buy the underlying stock, you pay the stated strike price to the issuing company. The difference between the strike price and the price of a share, minus the cost basis, is taxable income. It is not a capital gain because you did not own the shares prior to exercising the warrants.

Debt is sometimes issued with warrants to purchase shares of the borrower’s stock – typically at a discounted exercise price from fair market value. The warrants give the lender an equity upside in the company in addition to the interest earned on the debt agreement.

Compensatory warrants issued for services are taxed like compensatory non-qualified stock options, i.e., they are not taxed upon receipt as long as the warrants are priced at fair market value (which is usually the case). The exercise date of the warrant is the taxable event.

Taxing Gains and Losses

Capital gains are taxable in the year they are received as income, and capital losses may be deducted from the income tax returns of the warrant holder in the year redeemed.

The cost basis of the warrants is the fair market value on the date of distribution, but it is not taxable income. The warrant cost basis amount is recorded as a reduction of your cost basis in the parent stock as a non-dividend distribution.

Warrants. The warrants become exercisable either 30 days after the De-SPAC transaction or twelve months after the SPAC IPO. The public warrants are cash-settled, meaning that the investor must pay the full cost of the warrant in cash to receive a full share of stock.

Warrants are generally issued by the company itself, not a third party, and they are traded over-the-counter more often than on an exchange. Investors cannot write warrants like they can options.

Subtract the exercise price from the market price to find the intrinsic value of the warrant. Suppose the market price is $50 per share and the exercise price is $40. This gives you an intrinsic value of $10 per share. Divide the intrinsic value by the conversion ratio to find the value of one warrant.

Warrants simply get renamed to the new ticker during the merger. You do not lose the warrants simply because you hold them over the ticker change. Buying “equivalent” shares is not necessary.

While warrants generally expire in one to two years, they can sometimes have maturities well in excess of five years. In contrast, call options have maturities ranging from a few weeks or months to about a year or two; the majority expire within a month. Longer-dated options are likely to be quite illiquid.

Warrants are securities that have payoffs similar to plain vanilla traded call options, but a dilution impact when exercised, similar to employee stock options. As the strike price is less than the market price of the stock, this dilutes the interest of the existing shareholders.

What happens at expiry? Call Warrants: if the settlement price of the underlying is above the strike price at expiry, the call warrant is deemed to be “in-the-money” and the holder will receive a cash payment. Otherwise the warrant will expire worthless.