Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.
Dear Professor Succo,
Would you be so kind to explain to me the difference between an option and a warrant?
An option can be listed or "over-the-counter". A listed option is issued or underwritten by the Option Clearing Corporation (they guarantee clearing and payment) and the price is disseminated on an exchange. An option is "created" when any qualified participant wants to sell or buy: the seller does not need to borrow the option like a short seller needs to borrow a stock.
A clearing price is determined between two parties and a contract comes into existence, a simple agreement between two parties. The number of contracts that can be created is only limited by the "float" of the stock: the currently existing tradeable outstanding shares already issued by the company. There are normally position limits any one participant can buy or sell on any one security.
An "over the counter" option is nearly the same, only that it is not listed on an exchange and not cleared by the OCC. It is simply an agreement between two parties subject to the current outstanding shares. The two parties take the risk upon themselves of clearing the trade. There is very little reporting to regulatory bodies about the size and nature of these transactions.
In both cases money only is exchanged between the buyer and the seller.
A warrant is much different. Although a warrant is an option, it is a special kind of option. A warrant is issued (sold) by the company itself, so the company takes the money in for corporate purposes. Warrants are normally longer term in nature, lasting several years, and there is a finite number of them (unlike options that are created at the time of the transaction). A warrant consequently when exercised changes the "float" and outstanding shares of the company; it is dilutive.
Warrants then trade like stocks where a buyer is buying from either a seller that already owns them or is shorting them and needs to borrow them. This is very different than an option where the seller just creates the contract. Warrants therefore trade somewhat on the "availability" of the warrant: there is a scarcity value.
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