Benefits and Risks of Warrants

Warrants have increased in popularity since their inception on the Australian stock market in 1991, and they can be a valuable trading tool to add to your arsenal of financial devices. This is especially relevant if you are interested in gaining leverage or trading declining markets.

Of course, any benefits are counter measured with the appropriate risks, and warrants can be complex trading elements. It is important to understand how to use warrants before you make any financial commitments.

Here is a quick snapshot of some of the risks and rewards commonly associated with warrants:

Advantages

  • Leverage - For a minimum initial outlay, you can access large financial gains.
  • Diversity - Access a wide range of assets, or even an entire index using warrants.
  • Flexibility - Unlike some other derivatives, warrants are extremely customisable, but this also means you have to make sure you understand the warrant. Ensure you are getting appropriate value.
  • Minimise Losses - Depending on the warrant, you can usually only lose your initial outlay on the warrant itself (unlike futures).
  • Trade Declining Markets - Put warrants allow you to speculate on falling markets, and you can also use warrants as a hedging tool to protect your portfolio.
  • Dividends and Other Benefits - Utilise investment warrants to access dividends, franking credits and gain benefits from capital growth.

Disadvantages

  • Stock Market Declines - Warrants are susceptible to all the market conditions associated with the underlying asset, which includes potential for declines.
  • Market Movements - If the market moves against you, your warrant could become worthless.
  • Expiration Date - While warrants have longer terms than some other derivatives, usually they still expire. It's important to know when to exercise a warrant.
  • Liquidity - Depending on the warrant, liquidity may be an issue and you may get stuck with a worthless warrant.
  • Issuer Risk - While the ASX ensure all issuers meet eligibility criteria, it is not a guarantor for all warrants. Warrants are flexible, and it's important to understand any product disclosure statements.

Warrants can be an enriching tool for investors, so take the time to learn more about warrants and discover how they can add value to your stock market trading.