Shorting Options and Warrants

In most of my articles about options and warrants, I refer to options and warrants as though they are interchangeable (interchangeable, not fungible), but in my recent article about short options risk I only referred to options, and never actually mentioned warrants, and with good reason.

The article about short options risk does not apply to warrants, because warrants cannot be traded short (i.e. cannot be sold naked). Warrants can (and often should) be used to make short trades on their underlying markets (e.g. buying a put warrant that is based upon a stock index), but they cannot be traded short as an independent trade.

The reason that warrants cannot be traded short is that they are not a contract between two traders (as options are), but are a contract between the warrant issuer (financial companies such as Deutsche Boerse and BNP Paribas) and the trader. Unlike options, where the terms of the options contracts are set by the exchange that offers the options markets, the warrant issuers get to set the terms of the warrants contracts.

So, while options and warrants are interchangeable in most respects (e.g. the same underlying markets, the way that they are traded using calls and puts, etc.), they are not interchangeable when it comes to short options trades, for which actual options must be used.