Understanding what a warrant is can be very challenging when navigating the crypto market as a beginner, and in some cases, even as an experienced investor. There are many important things to consider when trading derivatives, so in this article, we will explain what this product is, how it can be bought and sold, and how its valuing mechanisms work.

What Is a Warrant?

A warrant is a derivative product, a proof of buying and selling at an expected price in the future. They are very similar to options in the sense that they too are contractual certificates representing that the owner has the right to buy or sell an asset from a specific issuer, for a certain price, at a set period in time.

The warrant holder - the person who owns that contract - acquires a right and not a liability, meaning that if the contract is actually unprofitable before being realized, its holder is able to withdraw, while the issuer has only the right of being realized.

To acquire this right, investors have to purchase warrants, and those can be divided into two groups:

Call Warrants

Analog to the options & stock market trade that most investors are used to, call warrants usually capitalize on the movements of the rise of an asset in price. Meaning: the higher an asset goes, the more the trader can profit from that movement.

This investment is considered to be high risk in derivative trading and is usually preferred by experienced traders who are comfortable with uncertainty and speculation.

Put Warrants

Put warrants give their holder the right to sell a number of shares of an asset at a specific price either before or on a current date. It is considered a less risky type of trading than call warrants.

Institutional players usually issue this type of warrant to attract large sums of investment, without having to honor extreme market fluctuations in case the price of the underlying asset falls. However, this may be considered a negative point to investors, adding a degree of risk and loss capacity, even if more controlled.

Both call and put warrants have an expiration date that defines the amount of time in which the asset has value. The exercise rules may vary depending on where that asset is being traded. For instance:

American warrants can be exercised any time during their validity;
European warrants can only be exercised on their settlement date.

Understanding the Basics

To exemplify, let us take a look at the warrants below:

BTC 21FEB 44000 P
BTC 21FEB 44000 C

• BTC stands for the name of the target asset;
• 21FEB is the expiry year and month of the warrant;
• 44000 is the strike price of the asset;
• “P” or “C” at the end mean that they are either a “put” or a “call” warrant.

The following values are set when the contract is issued.

Strike Price

The strike price of an asset is the value agreed upon when the purchase is made. Generally, when the asset’s price gets closer to the strike price, the more valuable the warrant becomes.

Entitlement Ratio

The Entitlement Ratio is the number of warrants necessary to be exchanged for one unit of the target asset being negotiated. For instance, if the entitlement ratio is 1, one warrant can be exchanged for one target asset. If the ratio is 1,000, 1 unit of the target asset can buy or sell 1,000 warrants.

Expiry Date

This is the last day that the warrant is valid. After this date, the buyer has the right to exercise the transaction at the strike price. Once it expires, the exchange automatically liquidates the asset for users who still hold the warrant.

How Is a Warrant Valued?

There are two ways to value a warrant:

• Intrinsic Value: Consists of the difference between the target asset price and the strike price during the time of exercise (the period between emission and expiry date).

• Time Value: This is embodied in the premium and represents the expectations of the holders for future value fluctuations or, in other words, the valuation of the expected possibility of future profit.

It is important to note that the value and price of warrants are directly impacted by market fluctuations and volatility, which lends higher probabilities of profit for investors willing to take the chance. This lends speculative value to traders that are able to negotiate these contracts before they reach their expiry date, maximizing margins and profit.

In terms of price, the settlement price of a warrant is given by: the intrinsic value of the warrant divided by the entitlement ratio. To the holders of profitable warrants at the expiry date, the settlement is made in two different ways: in the form of the targeted asset or cash.

Gate.io, for instance, uses the second method: USDT to settle profits and losses.

Conclusion

Every financial transaction needs to be carefully studied for the investor to understand the stakes of the investments they are planning to make and the best times to buy, sell, or keep the contracts acquired. That is also the case when considering warrant transactions.

While it presents itself as an interesting and profitable investment for trading and maximizing profit, understanding how these transactions work is necessary to achieve good results.

If you want to learn more about warrant trading, we have an article that goes further into this subject.