A warrant is a call option, which gives you the right (but you are not obliged) to buy a predetermined number of equity shares within a stipulated time frame at an agreed price. Normally, a nominal margin of about 10 per cent of the agreed price, is payable when warrants are subscribed by the investor.

The important difference between a normal call option and a warrant is that warrants are for a longer duration (1 to 5 years) as against the duration of a call option which is usually only a few months (normally up to 3 months in the case of stock options on the NSE and BSE).

Warrants are normally issued by companies for the benefit of a certain class of shareholders (i.e. promoters or institutional investors) or to raise capital over a period of time or reduce interest cost (by attaching warrants to debt instruments).

 
What makes warrants attractive to an investor is that he acquires the right to convert the warrant into equity shares at a predetermined price at a future date. Instead of investing the full amount in buying a share, a warrant investor pays a nominal margin (about 10 per cent) and will exercise his right to convert into a share (and pay the difference between agreed price less margin) only if the market price of the share at that time is higher than the agreed price. Conversely, in case the market price is lower than the agreed price, the investor is not obligated to exercise the warrant and will simply allow the warrant to lapse. However, the margin paid would be forfeited by the company in this case.

Furthermore, since warrants are usually tradable, a warrant holder is not bound to hold this instrument until it becomes exercisable. He can sell his warrants by selling them on the exchange anytime before the exercise date (warrant prices would normally track the market price of the share).

Example: Company ABC has issued warrants to its shareholders at a price of Rs 110 per share (current share price is Rs 100). Margin payable is 10 per cent. Warrants are to be exercised 12 months later.

Twelve months later if the price of the share has moved to Rs 150, the warrant holder will exercise the warrant and make a profit of Rs 40 (Rs 150 – Rs 110). In case the price of the share drops to Rs 80, he will not exercise his warrant and allow the margin to be forfeited thereby restricting his loss to Rs 10 per share (margin paid). Now instead of buying the warrant, if he had bought the share at Rs 100, not only would his loss have risen to Rs 20 (Rs 100 – Rs 80) but he would have also blocked the full amount of Rs 100 for 12 months (as against margin of Rs 10 for 12 months).

Remember that the warrant holder does not enjoy the same rights as an equity shareholder, such as voting rights, the right to receive dividend, etc. until the warrant is converted into equity.