As you dig deeper into the world of investing you're bound to be confronted with some terms you've never heard of before. Investing can be as simple as you want it to be, but it never hurts to be informed.
With that in mind, we've decided to take a look at two terms that you may come across over the course of your investing journey: stock warrants and stock options.
First, let's quickly go over exactly what a stock is. A stock is a type of security that represents part-ownership of a company. When you invest money into a stock, you receive shares in that company, which lets you know exactly how much of that business you now own. These shares are issued by the company in order to raise capital.
Stock warrants, on the other hand, give the holder the right to buy a stock at a specific price and on a specific date. Holding a stock warrant gives you no ownership of the company in question, it only acts as a contract that the company is legally obligated to honor if you choose to exercise it.
Companies issue stock warrants in order to raise capital quickly, and they are particularly useful in the early stages of growth as investors can lock in extremely low prices for a minimal investment and potentially make a lot of profit, while the company benefits from generating money instantly.
For example, a company going public could sell warrants at $10 while its stock is trading at $100 dollars. This warrant will guarantee that you can buy the stock at $100 any time within the next five years. If the stock price increases to $200 during that time, the warrant holders can exercise their right to buy and get shares at a large discount. The investors benefit by making a profit, and the company benefits by raising much-needed capital at an early stage, and by gaining future capital when the warrants are exercised.
Stock options are bought by investors who are speculating on whether a stock will go up or down in the future. Call options indicate the buyer believes the stock is set to rise, and put options indicate the buyer believes the stock is going to fall.
Similar to stock warrants, stock options give buyers the right to purchase stocks at an agreed price and date. One key difference, however, is that stock options are not issued by companies. When purchasing stock options, you are entering into a transaction with other investors.
For example, if a stock is trading at $50 and you believe it is going to rise by $10, you can purchase a $60 call option. These options will have an associated price and date. If the price were to rise to $80 before the date expires, your options are now worth $20 profit as the stock is trading at $20 higher than the price you have a contract to buy it for.
Stock options are inherently risky. You are essentially betting on the future price of a stock. Markets can move up or down for an extremely wide variety of reasons. If your options don't hit the required price by the specified date, they will expire with zero value. Predicting the market incorrectly could be extremely costly.
Both warrants and options come with a certain degree of risk. Each can be extremely lucrative if utilized correctly, but they also require that you accurately predict the future of a company. As the COVID-19 pandemic showed us, markets are entirely outside of our control and even the most heavily researched predictions can be rendered useless by external factors.
A much more reliable way to grow your investments is by buying and holding valuable stocks long term. With this strategy, while you are still trying to predict the future of a company, you're at much less risk of losing everything. Why not take a look at our article on the best way to buy stocks to get a feel for how to get started.
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