Call Warrant

A call warrant is a financial instrument that gives the holder the right, but not the obligation, to purchase a specific quantity of an underlying asset at a predetermined price within a specified period. The purpose of call warrants is to provide investors with an opportunity to gain exposure to price movements.

Call warrants can be used to speculate on the future price increase of the underlying asset or to hedge existing investments. Call warrants are important because they offer investors potential profit opportunities and flexibility. In addition, by purchasing call warrants, investors can leverage their investment capital and potentially amplify their returns if the underlying asset price rises significantly.  

• Call warrants give the holder the right, but not the obligation, to purchase a specific quantity of an underlying asset.
• They are tradable securities listed on stock exchanges, providing investors with opportunities to gain exposure to the price movements of underlying assets, such as stocks or commodities, at a fraction of the cost.
• Call warrants can be used for various purposes, including speculation on price increases, hedging existing investments, or leveraging investment capital.
• The value of a call warrant is influenced by factors such as the price of the underlying asset, time to expiration, volatility, interest rates, and market demand. It offers investors flexibility and potential profit opportunities while managing risk and capital.

A call warrant is a financial instrument that grants the holder the right, but not the obligation, to purchase a specific quantity of an underlying asset, such as stocks, at a predetermined price within a specified period. It is essentially a derivative contract.

The key components of a call warrant include the underlying asset, the exercise price (also known as the strike price) at which the asset can be bought, the expiration date (the deadline to exercise the warrant), and the ratio of warrants to the underlying asset (e.g., one warrant for one share).

When the underlying asset's price exceeds the exercise price before the warrant expires, the holder can exercise the warrant, buy the asset at the predetermined price, and potentially profit by selling it at a higher market price. Conversely, if the asset's price remains below the exercise price or the investor chooses not to exercise the warrant, it may expire worthless.

Call warrants are tradable securities listed on stock exchanges, allowing investors to buy and sell them throughout their lifespan. The value of a call warrant is influenced by factors such as the price and volatility of the underlying asset, time to expiration, interest rates, and market conditions.

Suppose Sam purchases a call warrant at a price of $2 with the underlying asset being Stock X. Note that the exercise price in this is $30. In case Stock X’s price is more than $42, which is the break-even point at the time of expiry, the following diagram denotes the potential profit that he could earn.

The greater the price of the stock, the greater the profit potential. That said, in case the price of the stock lies between $30 and $32, individuals would still be able to exercise the warrant, however, at a loss following the warrant price’s deduction. If the price of the stock is below or at $30, exercising the warrant would not be a prudent decision. One must note that in this case, the initial outlay in this call warrant would be completely lost.

Let us look at the examples to understand the concept better.

Example #1

Suppose a Company ABC, a technology firm, issues call warrants for its stock. Each call warrant entitles the holder to purchase one share of ABC stock at an exercise price of $50 within six months. Let's say a trader, John, purchases 100 warrants for $2 per warrant.

If the price of ABC stock rises above $50 during the specified period, John can exercise his warrants and buy 100 shares at the predetermined price of $50 each. For instance, if the stock price reaches $60, John could exercise his warrants and buy the shares for $50 each, allowing him to immediately sell them in the market at a higher price, resulting in a profit of $10 per share.

Alternatively, if the stock price remains below $50 or John decides not to exercise his warrants, he can choose to sell the warrants to another trader. The value of the call warrants will fluctuate based on the stock price and the time remaining until expiration. Thus, these warrants allow John to profit from the potential price increase of ABC stock while limiting his initial investment. It allows him to participate in the market's upside potential without committing capital upfront.

Example #2

Consider that a mining company, XYZ Mining, issues call warrants for gold. Each call warrant allows the holder to buy 10 ounces of gold at an exercise price of $1,500 per ounce within the next three months. Sarah, a trader, decides to buy 50 call warrants for $3 per warrant.

If the price of gold rises above $1,500 per ounce during the specified period, Sarah can exercise her warrants and buy 500 ounces of gold at the predetermined price of $1,500 per ounce. For instance, if the gold price reaches $1,700 per ounce, Sarah could exercise her warrants and acquire the gold for $1,500 per ounce, enabling her to sell it at the market price for a profit of $200 per ounce.

On the other hand, if gold remains below $1,500 per ounce or Sarah chooses not to exercise her warrants, she can sell the call warrants to another investor. The value of the call warrants will vary based on the price of gold and the time remaining until expiration. Thus warrants offer Sarah an opportunity to capitalize on potential price appreciation in the gold market. She can benefit from the upward movement in gold prices without owning the physical commodity outright.

The value of a call warrant can be calculated using various pricing models, with the most commonly used one being the Black-Scholes model. The Black-Scholes model considers several factors, including the underlying asset's current price, the exercise price, time to expiration, volatility, risk-free interest rate, and dividend yield (if applicable). The formula for getting the theoretical value of a call warrant under the Black-Scholes model is as follows:

C = S * N(d1) - X * e^(-r * T) * N(d2)

Where:

• C is the theoretical value of the call warrant.
• S is the current price of the underlying asset.
• N() represents the cumulative standard normal distribution function.
• d1 = (ln(S/X) + (r + (σ^2)/2) * T) / (σ * sqrt(T))
• d2 = d1 - σ * sqrt(T)
• X is the exercise price of the call warrant.
• e is the base of the natural logarithm.
• r is the risk-free interest rate.
• T is the time to expiration (expressed in years).
• σ is the volatility of the underlying asset's returns.

In addition to the Black-Scholes model, alternative models and variations can be used to estimate the value of call warrants, such as the binomial option pricing model.

Let us look at the differences between a call warrant and a put warrant:

Let us look at the differences between call warrant and call option:

This has been a guide to what is Call Warrant. We compare it with the put warrant and call option, explain its examples, & how to calculate its value. You can learn more about it from the following articles –

• Stock Warrant
• Call Protection
• Covered Call