An exchange-linked warrant is a specific form of financial warrant, which is a derivatives asset similar to an options contract. However, there are some key differences between the two, as well as many different types of warrants. This article will focus on exchange-linked warrants, how they work and how you can get started trading them. We have also compiled a list of the top brokers offering exchange-linked warrants trading below.
What Are Warrants?
All warrants, not just exchange-linked warrants, are derivatives that give you the right to buy or sell an asset at a set price, though you are not required to do so. American style warrants can be exercised (that is, you decide to buy or sell the asset specified) on or before the expiration date. However, European-style warrants can only be exercised on the date the warrant expires. Overall, they work very similarly to options, where the main difference is the issuer. Options are issued by exchanges, while warrants are sold by the issuing financial body itself – for example, an equity warrant for a particular stock is issued by the company that issues that stock.
Another difference is the fact that warrants are normally longer-term than options, with some warrants expiring even 15 years after being issued. Warrants also generally cover a wider range of assets.
The conversion ratio is an important feature of warrants, indicating how many warrants you need to gain exposure to one unit of the asset. Often, one warrant gives you access to one unit (1:1 ratio) but sometimes you will need two or more warrants per unit. Warrants are sold for a fee, called the premium, which generally decreases as the expiration date approaches. The more advantageous the difference between the strike price and the security price in the market, the higher the premium will be. An advantage of warrants over other securities is that you cannot lose more than your initial investment.
What Are Exchange-Linked Warrants?
An exchange-linked warrant is a warrant traded on an exchange that is linked to securities also traded on that exchange. For example, you will find equity warrants, index warrants and FX-rate-linked warrants. ELWs are often found on major exchanges like the London Stock Exchange (LSE) and the New York Stock Exchange (NYSE).
Equity warrants, also known as stock-linked warrants, are exchange-linked warrants pegged to the price of a particular stock. Companies often use them to raise funds and make it more desirable for investors to purchase shares. In turn, this increases the liquidity and value of that stock.
A common strategy used by companies that are looking to release new shares is to release equity warrants in advance. Investors that purchase them will have the right to buy newly issued stocks on the expiration date at the set price. Those that do not exercise the warrant can still buy shares from the company at a later date but they will need to pay the market price, which may be higher than the warrant price.
The ticker of equity exchange-linked warrants is that of the stock with a W or WS at the end. For example, the company Adial Pharmaceuticals is listed with the ticker ADIL, so its stock-linked warrants would be listed as ADILW. Equity warrants can be stock-settled or cash-settled. With stock-settled warrants, you receive the corresponding shares upon exercise, which you can resell or keep. In cash-settled warrants, you receive the profit directly. Cash-settled warrants generally incur less taxation.
American Stock-Linked Warrant Example
Suppose the price of an Adial Pharmaceuticals stock is currently $5 and the company has released exchange-linked warrants that expire in a year with a strike price of $4 and a premium of $2. Although buying the warrant is more expensive than buying the stock at this time, you might expect the share value of ADIL to be quite volatile. By investing in warrants you will have the chance to buy stocks if the price increases but your profits will be mitigated if the price drops. You purchase 100 warrants for $200.
Scenario 1: the price of the stock crashes to $0.5 and you decide not to exercise the warrants. If you had purchased the stocks, you would have lost $450. Instead, you only lost the $200 premium you paid for the warrants.
Scenario 2: the price of ADIL stock increases to $10. You exercise your warrant and pay $400 for 100 shares instead of the current price of $1000. You immediately sell your shares. After the premium and other charges, your profit stands at around $400.
Index-linked warrants track the price of an index and are issued by financial institutions, often banks. These are mostly cash-settled but some will allow you to buy into a fund or ETF. Index-tracking exchange-linked warrants often have well-known indices as the underlying asset, like the Nasdaq 100 or FTSE 100. Index-linked warrants allow you to benefit from price changes with stocks that do not have associated warrants.
You can also use index-linked warrants to hedge, thus reducing your risk. For example, a trader might invest in an index fund, hoping it will increase in price, but also buy a put (sell) warrant to benefit in case the price falls.
There are many other types of warrants, for example, currency warrants, which track the exchange rate between two currencies, and commodity warrants, which depend on the price of specific commodities. These are mostly cash-settled and the exact terms and conditions depend on the exchange they are listed on.
Pros Of Trading ELWs
- Reduced Risk: Trading exchange-linked warrants is less risky than purchasing the actual asset, as you can decide whether to purchase it or not.
- Limited Losses: You can only lose the money you paid for the premium, as opposed to CFDs and other derivatives that can have unlimited losses when using leverage.
- Market Access: Warrants have a wider market range than options, allowing you to trade in commodities or forex, for example.
- Hedging: Warrants can be a good way to hedge your portfolio, reducing your risk.
- Tax Benefits: If you purchase securities and then sell them, you will pay tax and other fees on both transactions. Cash-settled warrants will only be taxed once. Moreover, in many countries, you will avoid stamp duty and similar taxes.
Cons Of Trading ELWs
- Less Common: Not all listed companies and exchanges offer exchange-linked warrants, so you will need to choose from those that do. Other derivatives like options are available for more securities and through most brokers.
- No Ownership Benefits: Owning stocks in a company often gives you voting and dividend rights. However, having a warrant does not give you these rights.
- The Premium: You will need to pay the premium to purchase a warrant, which is an added cost on top of the security cost.
- Can Be Confusing: Differences like American vs European warrants and individual regulations set by the issuer can make warrants more confusing or difficult to trade.
How To Start Investing In ELWs
Analyse The Market: Not all exchanges have warrants listed, so check which do. Also investigate different types of commodities and warrants.
Find A Broker: Find a broker that offers access to your preferred exchange-linked warrants. Many exchanges will allow you to trade directly on their platform but a good broker will offer you access to multiple exchanges at the same time. These are the key things to look for in a broker:
- Market Access: Accessing multiple exchanges will ensure you maximise your trading opportunities
- Security: For the most protection, your broker should be registered with a recognised financial body in your country
- Low Fees: Keep an eye out for things like deposit and withdrawal fees, commissions and other charges
- Customer Service: A broker with good customer service will offer you 24/7 chats or telephone lines, offering help whenever needed
Buy A Warrant: Buy your exchange-linked warrant of choice by paying the premium. Consider factors like expiration date, strike price vs current price, expected price movements, premium price and conversion ratio.
Monitor Your Warrant: Monitor the price of the underlying asset and other factors that can affect it.
Exercise The Warrant: If it is an American-style warrant, you will be able to exercise at any point, so make sure to cash in when the price is at its best. If it is a European-style warrant, you can decide to exercise it on the expiry date only.
Final Word On Exchange-Linked Warrants
Exchange-linked warrants are warrants traded on exchange markets. They can be a good way to gain exposure to price movements but, because they are less common, different companies and exchanges structure them slightly differently, so always make sure to read the small print. For advanced traders with a large portfolio, exchange-linked warrants can be a smart way to hedge against your assets.
What Are Exchange-Linked Warrants?
A warrant, similarly to options, gives you the right to buy or sell an asset at a set price on a certain date. American-style warrants allow you to exercise this right at any point up to the expiry date, while European-style warrants can only be exercised at the time of expiry. Exchange-linked warrants are warrants traded on exchange markets.
What Types Of Exchange-Linked Warrants Are There?
As well as the main American and European-style warrants, you will also come across equity warrants. These are also known as stock-linked warrants and are linked to the price of a particular stock or equity.
What Are The Benefits Of Exchange-Linked Warrants?
As opposed to other types of derivatives, exchange-linked warrants have limited losses and reduced risk. Investors can decide whether to exercise their right to buy or sell that warrant and if they decide not to, the maximum they can lose is the initial investment plus the premium paid. There are also some tax benefits with cash-settled ELWs.
What Are Index-Linked Warrants?
Index-linked warrants are a type of warrant that tracks the price of an index, such as the FTSE 100 or NASDAQ. They are typically issued by banks and other financial institutions and are a way to benefit from price movements in stocks that do no have specific warrants linked to them.
What Happens When Exchange-Linked Warrants Expire?
Once an exchange-linked warrant expires, holders can no longer use it. With American-style warrants, the holder has the right to buy or sell at any point up to the expiration date.