Warrants: A leverage to boost your investments

Warrants are derivative products that offer investors the opportunity to buy or sell an underlying asset, such as a stock, at a predetermined price before a expiry date. Primarily used for speculative or hedging strategies, warrants offer significant leverage, allowing to amplify gains, but also losses. Introduced in financial markets in the 1980s, warrants have become popular tools for investors looking to boost their portfolio. This article explores warrants, how they work, and the associated risks.

What is a warrant?

A warrant is a contract that gives its holder the right, but not the obligation, to buy (call warrant) or sell (put warrant) an underlying asset, such as a stock, at a predetermined price (exercise price) before an expiry date. For example, a call warrant on a stock allows the investor to buy this stock at a set price, even if the stock price increases above this price. The main attraction of warrants is their leverage effect: a small change in the price of the underlying asset can result in a large change in the warrant price.

Opportunities offered by warrants

Warrants offer several opportunities to investors:

• Leverage: The main advantage of warrants is the leverage they provide. For example, if an investor buys a call warrant for €1 and the price of the underlying asset increases significantly, the value of the warrant can quickly multiply, offering high profit potential with a relatively low initial investment.
• Speculation: Investors can use warrants to speculate on the rise or fall of the prices of underlying assets. For example, an investor anticipating a decrease in the price of a stock could buy a put warrant to profit from it.
• Hedging: Warrants can be used to hedge a portfolio against market risks. For example, an investor holding stocks can buy put warrants to protect against price decreases.

Risks associated with warrants

Despite their advantages, warrants carry significant risks:

• Total loss risk: If the price of the underlying asset does not exceed the exercise price before the warrant expires, it expires worthless, resulting in a total loss of the initial investment.
• Volatility: Warrants are extremely sensitive to changes in the price of the underlying asset, which can result in significant fluctuations in their value.

Concrete example

In 2024, an investor buys a call warrant on a stock for €1 with an exercise price of €50 and an expiry in six months. If, at expiry, the stock price reaches €60, the investor can exercise the warrant and buy the stock at €50, then sell it at €60, realizing a gain of €10 per share. If the stock price remains below €50, the warrant expires worthless, and the investor loses the entire initial investment of €1 per warrant.

Laws governing warrants

In France, warrants are governed by the Monetary and Financial Code and are subject to the supervision of the Financial Markets Authority (AMF). Warrant issuers must provide detailed information on product characteristics, associated risks, and costs, in accordance with MiFID II regulations.

Conclusion

Warrants are powerful financial instruments that can boost an investment portfolio through their leverage effect. However, they also come with high risks, including the risk of total loss of investment. Investors interested in warrants should understand how they work and integrate them into an overall investment strategy, taking into account their risk profile and financial goals. It is also recommended to consult a financial advisor before investing in warrants to ensure they align with your investment strategy.