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 generally cover a wider range of assets, offering investors more options for gaining exposure to different units. The conversion ratio is a crucial feature of warrants, indicating the number of warrants required to gain exposure to one unit of the asset.
While one warrant typically gives you access to one unit (1:1 ratio), sometimes two or more warrants are necessary per unit.
Warrants are sold for a fee known as the premium, which typically decreases as the expiration date approaches.
The greater the difference between the strike price and the security price in the market, the higher the premium.
One 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 and linked to securities also traded on that exchange.
Equity warrants, index warrants, and FX-rate-linked warrants are just a few examples.
ELWs are commonly found on major exchanges such as 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. This, in turn, increases the liquidity and value of that stock. A common strategy employed by companies 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 instance, Adial Pharmaceuticals is listed as ADIL in the stock market, and its stock-linked warrants are listed as ADILW. Equity warrants can be cash-settled or stock-settled. In cash-settled warrants, you receive a direct profit, while in stock-settled warrants, you receive the corresponding shares upon exercising that you can either sell or hold. Cash-settled warrants generally incur less taxation.
Example of American Stock-Linked Warrant
Suppose the current price of Adial Pharmaceuticals stock is $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 presently, you may expect the ADIL share value to be quite volatile. By investing in warrants, you will have the opportunity to buy stocks if the price increases, but your profits will be reduced if the price drops. You buy 100 warrants for $200.
Scenario 1: If the stock price crashes to $0.5, and you decide not to exercise the warrants, you only lose the premium of $200. If you had purchased the stocks, you would have lost $450.
If the price of ADIL stock rises to $10, you can exercise your warrant and pay $400 for 100 shares, selling them for a profit of approximately $400 after fees.
They often use well-known indices like Nasdaq 100 or FTSE 100 as underlying assets, and allow you to benefit from price changes with stocks that don’t have warrants.
You can also use index-linked warrants to hedge your risk. For example, investing in an index fund and buying a put (sell) warrant to benefit in case the price falls.
There are many other types of warrants, such as currency warrants, which track exchange rates, and commodity warrants, which depend on the price of specific commodities. The terms and conditions depend on the exchange they’re listed on.
Pros of Trading ELWs
- Reduced Risk: Trading exchange-linked warrants is less risky than purchasing the actual asset.
- Limited Losses: You can only lose the premium paid as opposed to derivatives with unlimited losses when using leverage.
- Market Access: Warrants have a wider market range than options, allowing trading in commodities or forex.
- Hedging: Warrants can be a good way to hedge your portfolio and reduce risk.
- Tax Benefits: Purchasing securities and selling them incurs 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.
- 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.