Investing in Warrants
Value of Warrants
The value of a warrant is determined by two main factors, its intrinsic value and time value. Its intrinsic value is the difference between the current price of the underlying asset and the warrant's exercise price. The factors that positively affect a warrant's time value are the expected volatility of the underlying stock and the warrant's time to maturity.
Why Invest in Warrants?
The main benefit of investing in a warrant is cost leveraging. When an investor invests in a warrant, he stands to gain from the exposure of the share price movement, albeit, at only a fraction of its cost. A warrant is more sensitive to the market movement compared to its underlying assets. Therefore, by investing in a warrant, the same allows investors to benefit from the upside at a limited cost. The downside risk of investment in warrants is restricted to the loss of the warrant premium, only in case of non exercise of warrants till maturity.
Risk and Return
The performance of a warrant is closely linked to the stock price movement of its underlying assets. For stocks likely to have higher valuation in future, the chances of reaping rewards from investing in warrants in such companies become relatively higher. However, if the market is experiencing a downward trend and the time to maturity of the warrants is limited, then investors remain cautious in buying them. In markets or stocks facing a high downside risk, companies do not find many takers for issue of warrants, if chances are high that their value may lapse on maturity without coming across a scenario in which the investor could exercise his rights.