Warrants are financial instruments issued by banks and other institutions which entitle you to buy (call warrants) or sell (put warrants) a specified underlying instrument (the “underlying”) during a specified exercise period or on a specified date. Warrants are derivative products, in that their price depends on the performance of another asset (the underlying asset). Warrants are securities that give the holder the right, but not the obligation, to buy a certain number of securities (usually the issuer‘s common stock) at a certain price before a certain time.

The paper highlights some of the key distinctions between warrants and options as follows:

• Options are traded on an exchange exclusively for options (options exchange), warrants can be listed on stock exchanges.
• Warrants are issued by a company or a financial institution that trades in warrants on specific shares, while options are issued by the options exchange.
• The exercise period for a warrant (the period during which the investor can exercise their right) is usually longer than that for an option.
• The conditions for options are defined by the options exchange and are very standardised. Warrants are considered over-the-counter instruments, and thus are usually only traded by financial institutions with the capacity to settle and clear these types of transactions.

Classification of Warrants

Warrant can be classified into two categories: Call warrants and Put warrants. Call warrants that give the right to buy a specific underlying value, are known as ‘Call Warrants’. Put warrants give the right to sell a specific underlying value, are known as ‘Put Warrants’. Investors in Call warrants and investors in Put warrants have different expectations in terms of the performance of the underlying. Investors buying call warrants expect the price of the underlying to go up during the life of the warrant so that the option rights are worth more and the price of the warrant rises as a result. Investors in put warrants expect the price of the underlying to fall so that the price of the warrant rises. Holders do not normally exercise their option rights, but instead aim to sell back their warrants at a higher price.

The paper details the several reasons why people often invest in warrants and highlights the following incentives:

1. Leverage
2. Speculation
3. Investment
4. Income
5. Cash extraction
6. Portfolio protection and hedging
7. Limiting losses
8. Market exposure
9. Meeting specific requirements
10. Tax effectiveness

Features of Warrants

The common warrant features presented in the paper are as follows:

• Underlying instrument – A warrant derives its value from some other ‘thing’ or instrument. The underlying instrument may be a security (such as a share in a company including overseas securities & ETFs), a share price index, a commodity, or a currency.
• Exercise price – This is the amount of money which must be paid by you (in the case of a call warrant) or by the warrant issuer to you (in the case of a put warrant) for the transfer of each of the underlying instrument(s) (not including any brokerage or other transfer costs).
• Expiry date – The expiry date is the last date on which the warrant can be exercised.
• Exercise style – Warrants can be either American style or European style exercise.
• Conversion ratio – The conversion ratio is the number of warrants that must be exercised to require the transfer of the underlying instrument.

Warrants are broadly split into investment-style products and trading- style products. Trading-style warrants typically involve equity warrants, index warrants, barrier warrants and MINI warrants. Whilst investment-style warrants include endowments and structured investment products,

The paper then focuses on a specific type of warrant called turbo warrants. Turbo or knock-out warrants are contingent in nature: if the price of the underlying instrument touches a predefined point (the barrier) during the turbo’s life, the warrant is terminated ahead of time. The holder, in these circumstances, cannot exercise his or her right and will lose the premium paid. Two types of turbo warrants are highlighted in the paper: Turbo call warrant and turbo put warrant. A Turbo call warrant may produce a high return if the underlying asset increases in value. Turbo put warrants provide an opportunity for a high return if the underlying asset falls in value.

Shariah non-compliance of Warrants

The paper ends with considering the Shariah non-compliance of warrants. Some Shariah scholars argue that warrants are not Shariah compliant as they are a sale of something not in one’s ownership. This is because warrants are traded independently from the underlying asset. Other Shariah scholars state that Warrants are simply rights to buy, or a mere promise. such promises cannot have any consideration in lieu of it as they are not property (Mal) nor valid rights (Huquq). The ‘right to buy’ is a commitment, pledge and promise to transact. Let alone being lawful commodities, promises are not even assets. If the warrant is not a valid subject matter, then conventional warrant agreements are in reality Bay’ al-Ma’dum. Bay’ al-Ma’dum refers to a sale of a non-existent commodity, such transactions are void and invalid in Islamic commercial law.

Shariah Alternatives to Warrants

The paper ends with proposing alternative Shariah compliant structures that can be used instead of warrants to give some of the benefits of warrant. The following are explained:

• Wa’d: If the incentive element of a warrant is considered, an alternative Shariah compliant incentive can be offered as a substitute to a warrant. A unilateral Wa’d (promise/undertaking) agreement can be structured to offer incentive features of a warrant. The seller of the warrant can instead make an undertaking to transact equity with the buyer for a limited time at a pre-determined price or market rate.
• Bay’ Al Arbun presents many similarities with a Call Option and Call Warrant since both can be employed as strategies of hedging risks.
• If Shariah compliant hedging is the objective for using warrants, Tahawwut is a plausible alternative. Tahawwut refers to a hedging process/mechanism that is used or offered by Islamic banks and financial institutions to help mitigate a specific type of such as FX risk, market risk, liquidity risk, counterparty risk, etc.