A Market for Private Investors
Covered warrants differ from options in that they are not contracts, but the two types of derivative have plenty in common. The covered warrant is an exchange-traded packaged derivative mainly for private investors and is covered because the issuer simultaneously buys the underlying stock or financial instrument.

The product has flourished for some years in continental Europe. It was only in late 2002 that the London Stock Exchange (LSE) introduced it to the UK with a perceived aim of obtaining a significant presence in derivatives. In London so far, covered warrants, except in the FTSE-100 index, have made slow progress.

To trade in this product, you will pay a small premium, which gives you the right to buy or sell the underlying asset. As with options, covered warrants are split into Calls and Puts and, as time passes, they become less valuable, which is reflected in a declining premium. Every covered warrant is normally traded before its maturity date.

The biggest turnoff about covered warrants is that they are expensive compared with, for example, options. The compensating factor is that they are user-friendly. Covered warrants cannot be shorted, which is another limitation. But unlike in spread bets or CFDs, you cannot lose more than 100 per cent of your money. It is a significant advantage to the type of unsophisticated investor that is typically attracted to the product. At the end of their term, covered warrants that are in the money are automatically closed.

No stamp duty is payable on your purchase of a covered warrant, and as owner, you will receive no dividend from the underlying share. You will be liable to capital gains tax on any profits.

Some warrants are traded on the Central Warrants Trading Service platform, which is part of SETS, the LSE’s electronic order book, and the product may generally be traded via retail service providers.

Conventional Warrants
The conventional warrant is a different animal from the covered warrant. It may be used to buy a specified number of new shares in a company at a specified exercise price either at a given time, or within a given period.

Companies like to issue conventional warrants because they do not have to include them on the balance sheet. Warrants tend to rise and fall in value with the underlying shares, sometimes exaggerating the movement. They are not part of a company’s share capital and so have no voting rights.

Sometimes the warrants are packaged as a sweetener to accompany a bond issue. Capital gains tax is payable on profits.