Stock Options and Warrants
After the Troubled Asset Relief Program, stock warrants, not options, made a comeback. The US Treasury infused bailout dollars into large corporations in exchange for warrants, similar to stock options, which allow investors to buy a certain stock at a certain price at a certain time in the future. There are some differences, however.
Stock Options
A stock option is the right, not the obligation, to buy or sell stock at a previously agreed price in the future. This price is the strike price. Investors buy stock options that other investors write on their stocks. Purchasing stock options gives you the opportunity to profit when a stock rises or falls without actually taking delivery of the shares before the expiration date. Also, the most frequently traded stock options cost anywhere from pennies to $5, opening up the market for leverage.
Stock Warrants
While stock options are an agreement between two investors, stock warrants are an agreement between an investor and a corporation. The stock warrant is always issued by the company being traded, and new shares are issued to complete the purchase. So, while you may exercise stock options and take delivery of stock from another investor, delivery of shares from warrants are created via dilution of the other common shareholders.
One of the biggest benefits to stock warrants is that they generally carry a lower premium than do stock options, and also have expiration dates as far out as 15 years in the future. This allows investors to amortize their carry costs over a greater duration, as well as reduce the risk the warrants themselves will expire at a price “out of the money.”
