What Is a Detachable Warrant?
- A detachable warrant is a derivative contract attached to a security, which gives the holder the right to purchase the underlying asset at a specific price within a certain time.
- Investors who hold detachable warrants can sell them while keeping the underlying security, or sell the underlying securities while holding on to the warrants.
- Because they are attached to preferred stock, investors must sell warrants if they want to receive dividends.
Understanding Detachable Warrants
Often combined with various forms of debt offerings, detachable warrants can be removed by the holder and sold separately in the secondary market. So an investor who holds detachable warrants can sell them while keeping the underlying security, or they can sell the underlying securities while holding on to the warrants.
A warrant is a security that gives the holder the right, but not the obligation, to purchase a certain number of shares in the issuer’s company at a specific price before a specified time. In this way, a warrant is similar to a call option. Warrants are often attached to preferred stock or newly issued bonds in order to encourage demand for the debt securities.
Warrants are often detachable. A detachable warrant can be traded independently of the package with which it was offered. Many issuing companies choose detachable warrants when issuing bonds because it makes a debt offering more attractive and can be a cost-effective method of raising new capital.
The exposure to the rights provided by a detachable warrant can often gain the attention of investors who do not usually participate in the fixed income markets. In effect, a bond issuer includes detachable warrants in its sale of debt securities in order to obtain a lower interest rate and cost of borrowing than would be possible without the warrants, while a bond buyer is interested in the profit they could earn by converting the warrants to stock if the issuer’s stock price rises.
Because they are attached to preferred stock, investors may not be able to receive dividends for as long as they hold the warrants. Investors who want to earn some income from the dividend may find it prudent to detach and sell the warrant and keep the security in order to start collecting the dividend.
Investors must sell their warrants if they want to earn dividend income from the underlying securities.
An investor who owns bonds with attached warrants can sell those warrants separately while retaining the actual bonds. Likewise, the investor could sell the bonds and keep the warrants. Both securities are, therefore, treated separately even though they are issued in one package. This makes detachable warrants unlike call options, which are not detachable. The holder of a detachable warrant may eventually exercise it and purchase the entity’s stock or allow it to expire.
For example, an investor holds a $1,000 par value bond with a detachable warrant to buy 30 shares in the issuing company at $25 per share within the next five years. If the investor does not think the price of the common shares will get to $25 within five years, there is the option of selling the warrant in the open market, while still holding on to the bond. The investor may also do nothing and let the warrants expire after the five-year period passes. Furthermore, the investor could sell the bond and keep the warrant until it is exercised or it expires.
Detachable vs. Undetachable Warrants
Unlike detachable warrants, undetachable ones cannot be separated from their underlying securities. This means investors who hold these types of warrants must sell both the warrants and the underlying assets at the same time. The same applies if they decide to sell the underlying securities—the warrants must be sold at the same time. So once one is sold, the other is automatically transferred to the buyer.