What it means
Most people know warrants as the sweeteners that give the right to buy shares at a set price, which are call warrants. A put warrant is the opposite.
It gives the holder the right to sell, so it gains value when the underlying asset falls below the fixed exercise price. Put warrants are often issued by financial institutions and listed on an exchange, particularly in some Asian and European markets.
A bank creates the warrant, sells it to investors for a price, and then manages its own risk by trading the underlying asset. The investor gets a simple way to take a bearish view without short selling.
Unlike regular listed options, which are issued by a clearing house, a put warrant depends on the issuer. If the issuer fails, the holder may not be paid.
This credit exposure to the issuer is one of the main differences and should be considered in addition to the market risk. Companies can also issue put warrants, though this is rarer.
A company might issue them to give investors a guaranteed exit price, for instance as part of a funding deal. In that case the company is obliged to buy shares at the fixed price if the holder exercises, which can be a significant cash commitment.
The value of a put warrant depends on the same things as a put option: the price of the underlying asset, the exercise price, time to expiry, volatility and interest rates. As time passes, the warrant loses value unless the price falls, so a warrant held for too long without the expected move can end up worthless.
A warrant often has a conversion ratio showing how many warrants are needed per share. A nuance is that some put warrants settle in cash rather than delivering the shares.
The holder then receives the difference between the exercise price and the market price at expiry, which is simpler for investors who never wanted to own the asset. The terms in the prospectus say which method applies.
In practice
Real-world examples.
Example
An investor believes a property developer's shares are overvalued at $25. She buys put warrants with an exercise price of $22 from a bank. If the shares fall to $15, she gains $7 per warrant less the cost.
Example
A company raising money from a specialist investor offers a put warrant allowing the investor to sell shares back to the company at $10 in three years. The finance director records the obligation as a liability. The investor is willing to accept a lower cash return because of the guaranteed exit.
Example
A fund holds a large position in a bank's shares and wants downside protection. It buys cash-settled put warrants listed on an exchange. If the share price drops, the cash received from the warrants offsets part of the loss on the shares.
Formula
Calculation
Value at expiry per warrant = (exercise price - market price) / conversion ratio, if positive, otherwise zero
Profit per warrant = value at expiry - price paid for the warrant
Suppose an investor buys 10,000 put warrants on a company's shares at $0.50 each, a total of $5,000. The exercise price is $20 and the conversion ratio is 1 warrant per share. At expiry the share price is $14, so each warrant is worth 20 - 14 = $6.00. The total value is 10,000 x 6.00 = $60,000, giving a profit of 60,000 - 5,000 = $55,000.Case study
Seen in the real world.
Marlow Retail is an illustrative, fictional listed company that agreed a $5,000,000 investment from a private fund. The fund wanted some protection in case the share price fell, so Marlow issued it 500,000 put warrants with an exercise price of $10 per share, exercisable after two years.
Two years later, Marlow's shares had dropped to $6. The fund exercised its warrants, and Marlow had to buy 500,000 shares at $10, paying $5,000,000 in cash. The shares were worth only $3,000,000 in the market, so the company recorded an effective loss of $2,000,000.
The illustrative lesson was that put warrants issued by a company are a real liability. The cheap financing came with a fixed repayment that bit hardest when the share price was weakest, exactly when cash was tight.
Watch out
Common mistakes.
- Assuming a put warrant is backed by an exchange clearing house like a standard option, when it is usually backed only by the issuer.
- Holding the warrant until expiry without noticing that time decay steadily reduces its value if the price does not fall.
- Treating company-issued put warrants as free sweeteners, when they create an obligation to buy shares at a fixed price.
Questions
People also ask.
What is the difference between a put warrant and a put option?
A put warrant is issued by a company or financial institution as a security, while a standard put option is a contract created and cleared on an options exchange.
Is there a risk if the issuer fails?
Yes, because the holder's payout depends on the issuer's ability to pay, so the issuer's credit quality matters.
Are put warrants common?
They are less common than call warrants, and they are most often seen as bank-issued listed products in certain markets.
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