Finance

This is how the professional lever system works

You can invest your money on the stock market for the long term and achieve good long-term returns – or you can rely on short-term profits with knock-out certificates. But you have to be able to afford it.

There are products on the stock exchange with which you can turn little capital into a small fortune in a short time. A knock-out certificate is such a product. But there is a catch: the high return potential is only available in exchange for high risk.

Knockouts are extremely speculative. So before you start trading it, you should know what exactly you are getting yourself into. Our overview explains the functionality, advantages and disadvantages – and for whom these special certificates are suitable.

What are knock-out certificates?

Knock-out certificates are a special form of Derivatives. These are Financial products with which you do not invest directly in certain securities, but in a product that is based solely on these securities. These underlying securities are also called Underlyings.

You can use derivatives and certificates but not only on the development of shares and Bonds speculate, but also on those of Currencies, Raw materials or Indices such as the Dax.

In a nutshell, bet on a course. Because you do not own any shares in the underlying assets, you only conclude an agreement with the issuer of the certificate about payment. But it can fail when the editor goes broke. This so-called Issuer risk does not exist with an investment in funds, for example – your money is protected there as a separate asset.

The special thing about knock-out certificates is that they not only track the price development of the underlying but depict them many times over. If you win your bet, you will benefit from the price development several times, but if you are wrong with your speculation, your loss will also multiply.

Besides, you can To completely lose the money you have investedif the price of the underlying is the so-called Knock-out threshold exceeds or falls below (more on this below). Then there is usually the eponymous knock-out – the certificate expires worthless.

How do knockouts work?

Knockouts are special certificates because they are a Leverage to have. That’s why they are also called Leverage products or Leverage Certificates. With them, your gain – or loss – is multiplied. How much depends on the so-called Leverage factor from. With knock-out certificates you can bet on rising prices (long knock-outs or knock-out calls) as well as on falling prices (short knock-outs or knock-out puts).

The height of the lever results from the current level of the underlying and one fixed base price, also Strike called. The strike is often also the knock-out threshold. The following applies: The closer the price of the underlying asset comes to the strike, the higher the leverage.

It has to be like this, because this is the only way the product appears attractive to the investor – or in other words: worth the risk. Because the closer the knock-out threshold gets, the more likely that knock-out becomes – and your certificate is no longer worth anything. You would then have suffered a total loss.

At the example of knock-out certificates on the German Dax share index, we will show you what that could look like in concrete terms:

  • Let’s assume that the Dax is at 12,500 points and you assume that it will soon break the 13,000 point mark. Then you could buy a knock-out call to take advantage of this expected rising price many times over. They also assume that the index will never fall below 12,400 points. Therefore you buy a knock-out call with a strike and an identical knock-out threshold at 12,350 points.
  • In our example, the subscription ratio is 100: 1 or 0.01. It indicates how many knock-outs the investor needs to buy or sell a unit of the underlying asset. A subscription ratio of 0.01 means that you need 100 certificates to represent the Dax once.

The price of the knock-out call is calculated using this formula:

(Price of the underlying asset – strike) x subscription ratio

For our example this means:

(12,500 – 12,350) x 0.01 = 1.50 (euros)

The leverage of the knock-out call is determined using this formula:

Price of the underlying asset x subscription ratio / price of the knock-out

In our example:

12,500 x 0.01 / 1.50 = 83.3

  • This means that the knock-out call would multiply the price development of the Dax by a good 83 times – both a profit and a loss. If, contrary to your expectations, the Dax falls by two percent (250 points in our example), it would stand at 12,250 points and thus fall below the knock-out threshold. All your money would be lost.

What are the advantages and disadvantages?

Anyone who relies on knock-out certificates feels the opportunity to achieve huge returns with comparatively little capital investment, presumably as an advantage. However, this leverage effect can just as well be a disadvantage if the price of the underlying does not develop as you as an investor imagine.

After all: Compared to other financial products from the group of derivatives In the worst case, you cannot lose more than the capital you invested. With so-called CFDs or futures, there may be an obligation to make additional payments – so you have to pay in additional money. In contrast to warrants, fluctuations in the price of the underlying (volatility) also have no influence on the price of the knock-out. You can read more about the different types of derivatives here.

In addition, the performance of knock-out certificates transparentbecause they represent the movement of the underlying asset proportionally. And you can use it to speculate on many underlyings in which you would otherwise not be able to invest directly or only with difficulty.

In contrast, there is the high Risk that you will suffer major losses through leverage – up to total failure. An additional disadvantage is the issuer risk, i.e. the risk that you will not only lose your money if you speculate, but also if the issuer of the certificate becomes insolvent.

Who are knock-out certificates suitable for?

From the point of view of the industry, leverage products are like knock-out certificates Niche products for investors who know their way around and consciously accept the risk. If you are one of these professionals and can cope with a total loss, you can definitely try knock-out certificates – but always with the certainty that you are not investing your money wisely, but are gambling.

For all others: Better keep your hands off it. There are other products with which you cannot achieve such exorbitantly high returns in a short period of time, but you do not have to constantly fear total loss. So-called index funds or in short: ETFs (“Exchange Traded Funds”).

These are special equity funds in which a computer algorithm maps an index such as the Dax. So they always develop in much the same way as the underlying index. ETFs have the advantage that they comparatively cheap are and your Broadly diversified risk is.

If you hold an ETF for at least 15 years, your risk is further reduced. Far less thrill than with knock-out certificates.

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