Stock warrants and stock options differ in many ways but are also similar which can be confusing to people. The terms stock warrants and stock options are frequently used when talking about financial investments, but not everyone is aware of the differences between the two; even investors who deal with stocks on a daily basis struggle to do so.
In the corporate world, companies can attract and retain the best employees by offering stock options to their employees. By doing so, it encourages employees to work hard and contribute to the company’s success by giving them a reason to want to stay with the company. Whereas in order for companies to raise or generate more capital they grant stock warrants to investors. Also, individual investors or traders can trade stock options in regulated stock markets as well. It means we have 3 types of financial derivatives to deal with in this article: stock warrants, employee stock options, and exchange-traded stock options.
In this article, we will get to know the differences and similarities between stock warrants and stock options (exchange-traded and employee stock options) using several criteria like terms and conditions, types, ownership, lifespan, and many more. But before that, let’s get to know what these derivatives are all about.
What is a stock warrant?
A stock warrant is a derivative contract that grants an individual the right to purchase stocks of a particular company at a specified price and on a specified date. This can be done in order to raise money because it allows businesses to directly issue stock warrants to investors.
When a warrant is issued by a business, it specifies the purchase price of the stock as well as the warrant’s expiration date. Also, the issued warrants do not require investors to buy stock; it is entirely optional.
Stock options do not automatically grant an investor ownership of shares of stock. However, if the investor so desires, they can purchase the stock at the price stipulated by the warrant. This signifies that if the stock is trading higher, the investor could buy stock in the company at a lower price.
In a stock warrant, the terms of the warrant, its expiration information, and the time it can be exercised are listed on the warrant certificate that is given to investors. The stock warrant certificate represents the right to buy company stock at a specified price on a specific date in the future. It does not give ownership of the stock except when exercised.
When to use stock warrants
Stock warrants are typically issued by businesses to encourage investors to invest. In order to persuade investors to purchase the new security, companies frequently include stock warrants as part of a new-issue offering. Moreover, companies issue warrants to help with financing costs and to increase profits if the stock performs well.
Related: Exercising Stock Options and Taxes
What is a stock option?
A stock option is a contract that grants the holder the right but not the obligation to buy or sell shares of a company at a specified price known as the strike price and before a specified date. For employee stock options, the company grants the right to only buy shares of the company at an agreed price before a fixed date. Whereas for listed options, the trader could purchase the right to sell the shares of a company at a future date and at an agreed price, or the trader could purchase the options to buy the shares at a future date and at an agreed price. Usually, there is a deadline (expiration date) by which options must be exercised; if not, they will expire.
Stock options are similar to stock warrants in the sense that the investor is not required to exercise them. Additionally, just because you own a stock option doesn’t necessarily mean you also own the underlying asset, it must be exercised before you own the underlying security.
When to use a stock option
Using stock options depends on the type you have. The holder of an employee stock options contract is given the option, but not the obligation, to buy principal security, such as active stocks, at a predetermined price within a given time frame in the company where he or she works. While the holder of exchange-traded stock options can use theirs to trade, that is, to buy or sell.
Related: Equity Options Examples and Types
Stock warrants vs Stock Options (listed options)
Even though stock warrants and stock options are very similar in many ways, there are also significant differences between them. Let us see how stock warrants differ from exchange-traded options (also known as listed options). The following are some major differences between listed options and stock warrants.
- Issuer: Exchange-traded options are issued by a standard options exchange body like the U.S. Chicago Board Options Exchange, while stock warrants are issued by a specific company.
- Maturity: Stock warrants typically have longer maturities than listed options. The longest term for listed options is two years, while stock warrants can last up to 15 years.
- Dilution: Exercising stock warrants result in dilution due to the issuance of new stock from the company, whereas exercising exchange-traded options do not.
- Standardized and non-standardized contracts: Listed option contracts are standardized. All exchange-traded options must thus adhere to exchange-specified rules such as duration, size, exercise price, and trading unit. Whereas stock warrants are more flexible or non-standardized contracts between a company and investors in which the terms can be negotiated between the parties (company and investors).
- Profits: Companies issue stock warrants to encourage the sale of shares and to hedge against a decrease in the company’s value caused by a drop in the company’s share price. Thus, by purchasing a stock warrant, you are assisting the company issuing it regardless of whether it is exercised or not. However, in an exchange-traded option transaction, the company receives no direct benefit; rather, the benefit goes to the winning investor.
- Margin calls: Stock warrants do not have call margins but listed options do.
- Market principles: Exchange-trade options follows the principles of the futures market, while stock warrants abide by the principles of the cash market.
- Terms and conditions: The terms and conditions for stock warrants are set by the issuing company, while that of listed options are set by the appropriate regulatory bodies like the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA)
Stock warrants vs stock options for ESOs
Stock warrants also differ from employee stock options (ESO) in that,
- Ownership: Stock warrants are granted to investors while employee stock options are granted to employees of the company.
- SEC Registration: Stock warrants are only exercised when they are properly registered with the security exchange commission. Whereas employee stock options do not have to be registered before exercising your right.
Summary of the differences between stock warrants and stock options
|Basis of comparison between Stock Options vs Stock Warrants||Stock Warrants||Employee stock options (ESO)||Listed stock options|
|Meaning||A stock warrant is a legal agreement (security) that is granted by a company to an investor the right to purchase shares of a particular stock at a specified price on a specified date.||A stock option is a contract that grants an employee the right but not the obligation to buy shares at a specified price known as the strike price and before a specified date.||A stock option is a contract between two individual traders (or investors) that grants the right but not the obligation to buy or sell shares at a specified price known as the strike price and before a specified date.|
|Nature||Non-standardized security (Nature of contract is flexible)||Standardized contract||Standardized contract|
|Issuer||Issued by a specific company||Employee stock options are issued by companies||Exchange-traded options are issued by governing bodies like the Montreal exchange in Canada.|
|Ownership||Investors||Employee stock options are owned by employees of a company||Investors for exchange-traded options.|
|Terms and Conditions||Terms and conditions are set by the issuer||Terms and conditions are set by the company||T&Cs are set by the Security exchange commission|
|Lifespan||In stock warrants, the lifespan is from 1-5 years||From grant date to 10 years||From a few weeks to 2 years|
|Dilution||When you buy stock warrants it results in stock dilution (issuance of new stock)||When exercised, ESO dilutes the company shares||When you purchase listed options, it does not involve the issuance of new stock and therefore, no dilution.|
Similarities between stock warrants and stock options (Exchange-traded and ESO)
Both stock options and stock warrants are treated similarly, with the following similarities:
- Both instruments give holders the chance to increase their exposure and profit from stock market fluctuations without actually owning the asset.
- They give their holders the right to buy a specific amount of the principal asset at a fixed price and on a specific date.
- Unless exercised, both represent a right but no control over the principal asset.
- Stock options and stock warrants are both affected by stock price, strike price, or exercise price.
- In terms of pricing, both have the same components, namely Intrinsic Value and Time Value of Money.
- Listed options and stock warrants are of two types namely call and put options or warrants.
See also: Stock Options Vesting
The bottom line on warrants vs stock options
Beyond owning bonds, individual shares of stock, or alternative investments like precious metals or artwork, stock warrants and stock options can be used to diversify your portfolio hence the need to understand the differences between these investments: stock warrants and stock options.
On a whole, no matter which option you choose, each has advantages and disadvantages, and your decision will depend on your needs. It would be best to decide whether you want to invest for the long term or the short term after giving it some thought. Hence, when deciding whether to invest in either, understanding the risks and rewards is crucial.