A call warrant gives the holder of the investment the right, not the obligation, to purchase the underlying financial securities at a specific price on or before a certain date.
If the holder does not exercise the warrant, the call warrant will expire worthless. If the price of the underlying security goes up in value, it means the value of the warrant will also increase. As a result, the holder will earn profit only if he/she expects the price to move higher.
A call warrant is different from a put warrant, which is when the holder of the investment possesses the right to sell the financial securities at a specific price on or before a certain date.
How Does a Call Warrant Work?
Suppose Company X is trading with a share price of $100, and you anticipate that its share price will continue to rise. You purchase five call warrants (100 shares) for a price of $0.75 each, so your initial cost is 5 x 100 x $0.75 = $375. Also, suppose the strike price of the warrant is $110.
The share price of Company X eventually goes up to $115. Since the share price increased, the value of the warrants you purchased also increased.
The current value of each warrant is now $5.00, which is calculated by taking the current share price of $115 subtracted by the strike price of $110.
Since the share price increased, you can choose to sell the five warrants before their maturity date and earn a profit from the investment. Alternatively, you can wait until the warrants mature, but it means you will be betting that the share price will not drop below the strike price of $110; otherwise, you will be losing your initial cost of $375.
Call Warrants vs. Call Options
Warrants and options are similar because they allow an investor to purchase or sell a stock at a specified price on a set date in the future.
Unlike call options, warrants are issued directly by the companies that are looking to raise equity capital. On the other hand, call options are issued by options exchanges such as the Montreal Stock Exchange or Boston Options Exchange and are contracts between two individuals.
Usually, warrants also come with a longer maturity date compared to options. Depending on the call warrant, some may mature in a year or a few years later. Options may mature in a few weeks or months.
Call warrants can also lead to the dilution of existing equity shares because the company issues new shares when a warrant is exercised. Issuing new shares causes dilution for existing shareholders. On the other hand, exercising a call option does not lead to the issuance of new shares, so there is no effect on dilution.
Why Do Companies Issue Call Warrants?
Companies issue call warrants because it is a way for them to raise more capital. They are able to increase their capital when they sell warrants and when the newly issued shares are purchased by investors in the market.
Including warrants together with debt or equity issues (a sweetener) also lowers the cost of financing, which is also favored by companies as well.
Some companies may want to raise capital but are unable to because they may have low credit ratings or their debt level is too high. As a result, these companies may issue call warrants as a way to increase their cash flow.