A warrant, like an option, gives the holder the right but not the obligation to buy an underlying security at a certain price, quantity and future time. However, unlike an option, an instrument of the stock exchange, a warrant is issued by a company. The security represented in the warrant (usually share equity) is delivered by the issuing company instead of an investor holding the shares.

Companies will often include warrants as part of a new-issue offering to entice investors into buying the new security. A warrant can also increase a shareholder’s confidence in a stock, if the underlying value of the security actually does increase overtime.

There are two different types of warrants: a call warrant and a put warrant. A call warrant represents a specific number of shares that can be purchased from the issuer at a specific price, on or before a certain date. A put warrant represents a certain amount of equity that can be sold back to the issuer at a specified price, on or before a stated date.

Characteristics of a Warrant
Warrant certificates have stated particulars regarding the investment tool they represent. A holder of a warrant does not have any voting, shareholding or dividend rights. All warrants have a specified expiry date, the last day the rights of a warrant can be executed. Warrants are classified by their exercise style: an American warrant, for instance, can be exercised anytime before or on the stated expiry date, and a European warrant, on the other hand, can be carried out only on the day of expiration.
The underlying instrument the warrant represents is also stated on warrant certificates. A warrant typically corresponds to a specific number of shares. The exercise or strike price is the amount that must be paid in order to either buy the call warrant or sell the put warrant. The payment of the strike price results in a transfer of the specified amount of the underlying instrument.
The conversion ratio is the number of warrants needed in order to buy (or sell) one investment tool. Therefore, if the conversion ratio to buy stock XYZ is 3:1, this means that the holder needs three warrants in order to purchase one share. Usually, if the conversion ratio is high, the price of the share will be low, and vice versa.

Let us look at an example:
Say that XYZ shares are currently priced on the market for Rs. 150 per share. In order to purchase 1,000 shares, an investor would need Rs.1, 50,000. However, if the investor opted to buy a warrant (representing one share) that was going for Rs. 50 per warrant, with the same Rs. 1, 50,000, he or she would be in possession of 3,000 shares instead. If the share price of XYZ gains Rs. 30 per share from Rs.150, to close at Rs.180. The percentage gain would be 20%. However, with a Rs. 30 gain in the warrant, from Rs. 50 to Rs. 80, the percentage gain would be 60%.

Warrants can offer significant gains to an investor during a bull market. They can also offer some protection to an investor during a bear market. This is because as the price of an underlying share begins to drop, the warrant may not realize as much loss because the price, in relation to the actual share, is already low.

Conclusion:
Warrants can offer a smart addition to an investor’s portfolio, but due to their risky nature, warrant investors need to be attentive to market movements. This largely unused investment alternative, however, can offer the small investor the opportunity for diversity without having to compete with large, market-influencing institutions.