What is a Covered Warrant

A covered warrant is a security that gives the holder the right, but not obligation, to buy or sell an underlying asset at a specified price on or before a specified date. Such underlying assets include single stocks, baskets of stocks (e.g., sectors or themes), indexes (e.g., FTSE 100 Index), commodities and currencies. Covered warrants are listed on major international exchanges in London, Hong Kong and Singapore. It is called a "covered"' warrant because when an issuer sells a warrant to an investor, it will usually hedge (cover) its exposure by buying the underlying asset in the market. A covered option trade is settled T+3 in cash.

BREAKING DOWN Covered Warrant

A covered warrant bears many similarities to an option. It gives the investor the right to buy an underlying asset, like a call option, or sell, like a put option. It has a strike price and expiration date. Both covered warrant and option are composed of intrinsic value and time value. However, some aspects set them apart. A covered warrant can be either European style or American Style, the former indicating that exercise of the right can only occur on the expiration date, and the latter signifying that an investor can exercise the right anytime between purchase date and expiration date.

Also, options can be "written" — writing a call option is selling a call, which will obligate the seller to deliver shares at a set price on a specified date to the buyer if that buyer exercises the call; writing a put is selling a put, which will obligate the seller to buy shares if the buyer of the put exercises the right to sell at a set strike price. By contrast, a covered warrant can only be purchased. Another difference between a covered warrant and option is that the average life of a covered warrant is six to nine months, whereas options are mainly active within one- to three-month time frames.