DEFINITION of 'Naked Warrant'

A naked warrant, also known as a covered warrant, is a derivative that allows the holder to buy or sell a security, such as a bond or share. Unlike a normal warrant, it is not attached to a newly issued bond or preferred stock. Naked warrants are issued by financial institutions and can be traded on major stock exchanges.

BREAKING DOWN 'Naked Warrant'

Companies often issue bonds and preferred stock with warrants attached to them to increase demand for an equity or debt offering — and lower their cost of capital. Warrants are securities that give the holder the right, but not the obligation, to buy a certain number of underlying securities — usually the issuer's common stock — at a certain strike price. An American style warrant enables the holder to exercise at any time before the warrant expires, while a holder of European style warrant can only exercise at the expiration date.

Naked warrants are not the same as call options, because they are issued by private parties, not an exchange, and there is a much longer time to expiry. While options usually expire in less than a year, warrants generally expire in one or two years. And while similar to share purchase rights, share purchase rights only last a few weeks. For more on the difference between warrants and call options, read Understanding Warrants and Call Options.

Normal warrants are issued with an accompanying bond (a warrant-linked bond), giving the investor holding the warrant the right to exercise it and acquire shares of the company that issued the underlying bond. The company writing the bond is typically the same company issuing the underlying bond.

Naked warrants, on the other hand, can be backed by a variety of underlying securities, including stocks, and are considered more flexible. They are sometimes called "covered" warrants 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. Warrant exercise prices are typically 15% above the market price at the time of issuance and usually trade at a premium to the stock price.

Pros and Cons of Warrants

Stock warrants provide investors with extra leverage, but that makes them risky investments. When the price of the underlying security rises, the percentage increase in the value of the warrant is greater than the percentage increase in the value of the underlying security. This is fine when the stock market is rising — when they are a less risky investment than options because they take longer to expire. Conversely, when the share price falls below the strike price, the shareholder can lose some or all of their money.

RELATED TERMS
  1. Warrant

    A derivative that gives the holder the right, but not the obligation, ...
  2. Warrant Coverage

    Warrant coverage is an agreement between company and shareholders ...
  3. Harmless Warrant

    A warrant that requires the holder to surrender a similar bond ...
  4. Wedding Warrant

    A warrant that can only be exercised if the host asset, typically ...
  5. Piggyback Warrants

    Additional warrants that are acquired following the exercise ...
  6. Covered Warrant

    A covered warrant is a security that offers the right, but not ...
Related Articles
  1. Trading

    A User's Guide To Warrants

    A warrant is similar to option, except it's issued by a company. Learn all about these warrants and how to trade and value them.
  2. Trading

    Warrants: A Risky But High-Return Investment Tool

    Discover the advantages and disadvantages of warrants, a largely unexploited investment vehicle.
  3. Investing

    Bank Warrants Your Atttention

    Bank warrants are a lucrative way to make a bet that U.S. financials will once again be respected by the investing public.
  4. Investing

    Understanding Warrants and Call Options

    Understand the fundamentals of warrants and call options, and find out how these securities contracts are quite similar, but also have some notable differences.
  5. Trading

    Naked Options Expose You To Risk

    Find out why these enticing options can spell trouble for your bottom line.
  6. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  7. Trading

    NYIF Instructor Series: Warrants

    In this short instructional video Anton Theunissen explains what a warrant is and how it works.
  8. Investing

    Basics Of Federal Bond Issues

    Treasuries are considered the safest investments, but they should still be analyzed when issued.
  9. Investing

    U.S. Corporate Bonds: The Last Safe Place to Make Money

    There aren't many other sources right now for relatively safe, steady income.
  10. Investing

    A Guide to High Yield Corporate Bonds

    The universe of corporate high yield bonds encompasses multiple different types and structures.
Hot Definitions
  1. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  2. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  3. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
  4. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company has sold and replaces inventory over a period.
  5. Watchlist

    A watchlist is list of securities being monitored for potential trading or investing opportunities.
  6. Hedge Fund

    A hedge fund is an aggressively managed portfolio of investments that uses leveraged, long, short and derivative positions.
Trading Center