Warrant: definition, functioning and how to invest

Introduced in the 1980s, warrants are leveraged stock market products that can be used to boost a portfolio. Let's take a look at this financial product like no other!

Read more: Comprendre les marchés financiers

What is a warrant ?

Warrants are stock market products that enable you to invest in an asset (stock, index, commodity, currency) with leverage. Warrants behave like options. In other words, they give the holder the right to buy (in the case of a call) or sell (in the case of a put) an underlying asset at a predetermined price (the strike price) on a given date: the maturity.

The mechanics of warrants are similar to those of options. There are :

• Call warrants : Gives the holder the right, but not the obligation, to buy a specific quantity of an underlying asset. 
• Put warrants : Gives the holder the right to sell the underlying asset at a predetermined price within a specified period.
  

Thus, in the case of a bullish expectation on the asset, the investor will take a call position to profit from a rise in the asset. On the other hand, if the asset is expected to fall, the investor will opt for a put.

How to calculate its value?

The calculation of a call warrant's value can be performed through a range of pricing models, with the Black-Scholes model being the most prevalent. This model takes into account multiple variables such as the current price of the underlying asset, the exercise price, the time until expiration, volatility, the risk-free interest rate, and any dividend yield if relevant.

The formula Black-Scholes model is as follows:

C = S * N(d1) – X * e^(-r * T) * N(d2)

What happens at the end of the Warrant's life?

At the end of the warrant's life, the investor is repaid the intrinsic value of the warrant if it is positive. The intrinsic value of a warrant is the difference between the current market price of the underlying asset and the warrant's exercise price. If this difference is positive (i.e. the exercise price is lower than the current market price for a buy warrant, or higher for a sell warrant), the investor can exercise the warrant and obtain a gain..

To conclude

Les Warrants offrent un moyen intéressant d’investir en bourse pour les investisseurs qui disposent de connaissances suffisantes des marchés financiers. Ils permettent à leur détenteur de profiter d’une hausse d’un actif sous-jacent, en profitant de l’effet levier !

Read more: Zoom sur le métier de Trader exotique en Banque d'Affaires

Underlying asset: The underlying asset is the reference point on which the value of a derivative financial product (such as a Warrant) is built. This underlying asset can be a share, a currency, a commodity or a stock market index.

Strike: The strike price of a warrant is the price at which the warrant holder can buy or sell the underlying financial asset at a given future date. The strike price is set when the warrant is issued, and is predetermined.

Maturity: This is the deadline by which the warrant holder must decide whether to exercise his right to buy or sell the underlying financial asset at the pre-agreed strike price.