Warrants: What are they and how do they work?
Warrants are extremely popular in the Spanish market, and are no longer considered an exotic, state-of-the-art financial instrument. BBVA currently has more than 1,200 active warrants in Spain, and every month €20 million of premiums are purchased. But how exactly does this investment alternative work?
Warrants are nothing more than a type of option with specific characteristics and are very popular across Europe. They were massively sold throughout the 1990s in countries like Germany, France and Italy, and foreign issuers brought them to Spain in 1999. BBVA currently plays an active and decisive role in the Spanish stock markets where all types of warrants are traded.
What exactly is a warrant?
Warrants are securities that are traded in stock markets and grant the owner the right to buy or sell a certain asset or underlying security. It is important to stress that the investor acquires a right, not an obligation, and can exercise that right for a set period of time.
Warrants could be compared to leaving a deposit in a store to hold an article at a certain price. The deposit, like a warrant, allows us to see how the market evolves during a period of time and decide whether or not to purchase the product at the set price.Warrants are securities that are traded in stock markets and grant the owner the right to buy or sell a certain asset or underlying security. It is important to stress that the investor acquires a right, not an obligation, and can exercise that right for a set period of time.
However, warrants can be either the right to purchase (call warrant) or the right to sell (put warrant) and are referenced against an asset or underlying security (a share, an index, a currency, etc.). When acquiring a warrant, investors pay a non-refundable premium in exchange for this right. The right will remain active and can be exercised until the expiration date.
Warrants’ unique features
Investing in warrants is different from directly investing in the underlying asset, and as previously mentioned, allows investors to obtain returns based on the evolution of the underlying asset, without having to directly invest in this asset. As large quantities do no need to be invested, it can help to optimize portfolio diversification - so important when planning investments.
A warrant is a securitized option. In other words, an option on an asset in the form of a security that has an official listing, and it is traded in an organized market. Its price is therefore set transparently. The issuer of the warrant defines its characteristics (strike price, expiration date, type, underlying asset) and investors selects the warrant that best fits their profile in terms of market expectations.
What can warrant investments offer us?
Investing in warrants is simple and is not very different from the procedure of buying and selling shares. Warrant owners can buy or sell the same warrant as many times as they want. It is necessary to hold on to warrants until their expiration date to maximize the investment since there is a market that guarantees their liquidity.
Unlike stock, warrants offer the possibility of investing in rising or falling markets, so that taking a position can produce profit regardless of whether the market gains or loses. Small amounts can be invested in warrants, as profits multiply from the leverage effect if the market evolves as investors expected.
For example, a leverage of six means that investing €500 in warrants would be the same as investing €3,000 in stock. Or if the underlying security increases 5%, the leverage effect would make the warrant price gain 30%. Of course, this effect also has negative consequences if the market does not behave as expected.
Buying warrants is ideal to access certain markets at a lower cost (international markets or currency markets), and is also a good way to cover risk in a portfolio. Buying and selling warrants is similar to buying and selling stock. There are no additional requirements. It is simply recommended to be aware of their characteristics.