Introduction to stock trading
You would be familiar with the term “stock trading”. It is the process of buying and selling shares of a public-held company. Public companies will issue shares if they need capital to do financial activities like debt repayment and company expansion. You can pledge your real money and buy shares of a company. However, only the person with more than half of the shares will be in an operating position. Small investors with limited shares will get some benefits like dividends, voting rights in small decisions, etc. Apart from the benefits of being a shareholder in a company, you will have another advantage of making profits by selling the stocks you have when their price goes high. Most of the individual investors will do this to see some profits in the short term. During the trading of stocks, you will come across some offers and certificates of rights between the traders and brokerages. One such certificate of rights that we are going to discuss in this article is a warrant.
What is a Warrant in stock trading?
A warrant is a proof of rights certificate that a buyer and seller agree upon, to trade a particular stock for a price at a future date, irrespective of the stock’s price at that time. Usually, the seller of a stock will issue warrants to the buyers, many days before the actual trading. The warrant will cost a small amount for the buyer. If the price of the stock after the agreed period is higher than the price in the voucher, the buyer will come at that date and get the stocks for a low price. On the contrary, if the price indicated in the voucher is higher than the future price of the stock, then the buyer will not buy the stock, thus the initial amount paid for the voucher becomes a profit for the seller. The process will be clear if you take a look at the below example.
Illustration for a warrant in stock trading
- Let us consider we are trading the stocks of Apple company in February 2020.
- Current price on Feb 2020 = $100 per stock
- Voucher price = $20
- Date of trading in the voucher = Dec 2020
- Price of stock of Apple on Dec 2020 = $250 / $75
- Price of stock in the voucher = $120
The warrant will have the following assurance for the seller,
I owe you the stock of Apple for $120 when you come with this voucher after ten months from now (Dec 2020)
Since the future price of the stock is $250, it is a large profit for the buyer to come back in December and buy the stock for $120 as per the deal. If the price in December is only $75, he will not get back and buy, using the voucher. In that case, the $20 payment for the warrant is the profit for the seller.