Warrant

A warrant is a security that can be bought and sold on the stock exchange. It embodies a right: the holder is allowed to buy or sell a specific asset later at a price fixed today. This asset is usually a stock, but it can also be gold, oil, or a currency. The word “allowed” is important: the holder does not have to exercise the right, they can simply let it expire. The price of the warrant itself is significantly lower than the price of the stock it refers to. Such securities are issued by banks, which earn money from them.

Leverage and the risk of total loss

Warrants are interesting because they have what is known as leverage. If the underlying stock rises by ten percent, the warrant can rise by a hundred percent. The reason is simple: much less money was invested, yet the holder benefits from the full price movement. With a small stake, one can thus bet on large movements.

However, the leverage works in both directions. If the stock falls, the warrant loses value disproportionately. And if the right ends up being worth nothing, the warrant expires worthless. The buyer then loses their entire stake, not just part of it. Unlike with a stock, there is no residual value whose recovery one could wait for.

For this reason, warrants are considered highly speculative. In Germany, banks must explicitly inform customers about this risk before a purchase. A second use case is hedging: anyone who owns many stocks can use a warrant that bets on falling prices to cushion losses. This works similarly to insurance, which you pay for in good times and hopefully never need.

Strike price, term, and time value

Three pieces of information determine every warrant. The strike price is the price at which buying or selling is permitted. The term determines until when the right is valid. And the subscription ratio indicates how many shares a warrant refers to — often it is a tenth or a hundredth.

An example makes this tangible. A stock is trading at 100 euros. A call warrant allows a purchase at a strike price of 110 euros and runs for one year. If the stock rises to 130 euros during this time, the right is worth 20 euros. If it stays below 110 euros, it is worthless, because no one voluntarily buys at a higher price than the market offers.

However, a warrant also has a price even when it would currently be worthless. This premium is called time value. It represents the chance that the price will still move before the end of the term. The time value shrinks with every passing day and is zero at the end of the term. A warrant therefore loses value even if the stock price does not change at all.

Warrants in portfolios and in financial news

In Germany, warrants are a mass-market product. Large banks issue hundreds of thousands of different variants that can be traded through ordinary online brokerage accounts. They appear there alongside stocks and funds, though usually only after an additional risk clearance. Related products are certificates and knock-out products, which work on a similar principle but have different details.

In the news, the term often comes up in connection with employee stock ownership plans. Tech companies in particular pay employees rights to their own shares. Such rights are also granted to investors during company takeovers and IPOs. In English, they are then usually called warrants.

A common misconception: a warrant and an option are not the same thing. An option is a standardized contract traded on specialized derivatives exchanges. A warrant, on the other hand, is a security issued by a single bank, which sets its own terms. If that bank goes bankrupt, the warrant becomes worthless, no matter how well the bet went.