# How do they work Are they suitable for beginners?

**Make high profits with little capital – or lose everything. Both are possible with leverage products. We explain what you should look out for when investing and whether everyone can dare to invest in this investment.**

When it comes to money, everyone ticks a little differently: some people hoard their income in their current account, where it is safe but not profitable, others take full risk and speculate with derivatives. This type of financial instrument also includes leverage products.

In this overview you will find out what exactly they are, how they work and what they all fall under. And also who should keep their hands off it.

### What are leverage products?

**Leverage products** are financial instruments from the group of **Derivatives**. These, in turn, are financial products with which you do not invest directly in stocks, indices, currencies or commodities, but whose price only differs from the so-called underlying **Underlyings** derives. This is where the name comes from: “derivare” comes from Latin and means “to derive”. You do not have any of these underlyings, but still have a share in their development.

At a **Leverage derivative**, a leverage product, you can **benefit many times over from the performance of the underlying asset** – the bigger the lever, the stronger. This means that you can achieve high returns with a comparatively low capital investment. **But:** You leverage your losses to the same extent – possibly up to a total loss. The prospect of high returns is therefore only against **high risk**.

### How do leverage products work?

What all leverage products have in common is that they work with you **can bet on rising as well as falling prices in order to participate disproportionately in the price development of the underlying**to which the leverage product relates. If you speculate on rising prices, the leverage product is called **Long** or **Call**, bet on falling prices **Short** or **Put**.

- Let’s assume you own a product with leverage 4, which is derived from a stock and with which you bet on rising prices. If this happens and the stock rises by 2 percent, your leverage product increases not just by 2, but – because of lever 4 – by 8 percent. If, on the other hand, the price of the stock falls by 2 percent, the value of your leverage product also falls four times.

### What kind of leverage products are there?

Leverage products is an umbrella term for many different derivative financial instruments, all of which function differently. The most important are **Warrants**, **Leverage Certificates** and so-called **“Contracts-for-Difference” (CFDs)**.

### Warrants

Warrants, also known as warrants, are the classic leverage products. You buy yourself the right (not the obligation) to purchase a certain underlying asset **predetermined price** (Option premium), within a certain **Subscription ratio** to a **specific time** (European option) or within a **set timeframe** (American option) to buy or sell.

How expensive a warrant is depends largely on it **running time** from: The shorter the remaining term, the less likely it is that the price of the underlying asset will change significantly – and therefore the lower the price. These papers are often issued by banks. The terms **Warrants** and **option** are often used synonymously.

With warrants you bet on a certain price development, **do not have to use your option**if the bet doesn’t work out. Your capital invested in the warrant, the **Option premium**, of course you would have lost anyway.

**An example:**You buy a warrant that entitles you to buy a share on day x for 100 euros – no matter what price the share is actually at on day x. An option premium of 10 euros is due for this right. In order for this to be worthwhile for you, the share must be more than 110 euros on day x, because then you would have recovered the premium of 10 euros and made some profit if you had exercised your option. The further the share is above 110 euros, the more profit for you. If, on the other hand, it is less than 100 euros, for example 97 euros, it makes no sense to use your option. Because then you would not only have lost the 10 euro bonus, but an additional 3 euros. If you do not withdraw your option, you “only” lose the premium. If the share was between 100 and 110 euros, for example 105 euros, you should use the option to lose at least half the premium.

**Good to know:** In this example, the subscription ratio is 1: 1 because the warrant gives you the right to buy one unit of the underlying asset (i.e. one share). But there are also other subscription ratios, for example 10: 1. Then you need ten warrants to buy or sell one unit of the underlying asset.

### Leverage Certificates

You can also use leverage certificates to speculate on the price developments of stocks, indices, commodities and the like and gain or lose disproportionately in the process. There are many different types of leverage certificates, for example **Knock-out certificates** and **Factor Certificates**.

All certificates – with or without leverage – are legally a **Bonds** the issuing bank. That means: If this goes bankrupt, your invested capital is part of the bankruptcy estate – and most likely completely lost.

At **Knock-out certificates** the height of the lever is calculated from the **current level of the underlying** and one **fixed base price**, also **Strike** called. The strike is often that too **Knock-out threshold**. The following applies: The closer the price of the underlying asset comes to the strike, the higher the leverage to make the product attractive to investors.

Because the closer the knock-out threshold, the more likely it is that the underlying will reach this threshold and the eponymous knock-out will occur. The certificate is then no longer worth anything – the result: total loss.

At **Factor Certificates** applies anew every day **certain factor**, by which the price development is multiplied – positive as well as negative. However, you should not hold these certificates for more than a day. **A rule of thumb:** The higher the leverage, the more likely the money will be lost.

Factor certificates do not have a knock-out but one **Adjustment threshold**. It is intended to prevent total loss by preventing the value of the certificate from falling below a specified limit in the event of sharp price drops. However, this is usually only shortly before the total loss – so in practice you have not gained much with it.

Also is a **Total loss possible anyway** – even if the price of the underlying only moves “sideways”, i.e. small swings up and down alternate over a longer period of time. Then a so-called **negative sideways return** – not good for you as an investor. The mathematical logic behind it isn’t particularly intuitive.

### Contracts for Difference (CFDs)

**CFDs** is also called in German **Contract for difference** or **Contract for difference**. You conclude a contract on the difference between the price of the base value when the contract was concluded and the price at the end of the contract. **This difference is paid out to you**when course has headed in the direction you had speculated on. Otherwise you have to pay the difference to the starting price. However, your losses are limited to the available balance on the CFD account.

Have CFDs **no term**, **no knock-out threshold**where they expire worthless, and **represent the base value exactly 1: 1**. There is a lever through the so-called **Margin** (Security deposit). If you invest in CFDs, you only have to deposit a fraction of the contract value as collateral, but you fully participate in the price development of the underlying asset. Mind you: again in terms of both profits and losses.

**An example:**Let’s assume you want to benefit from a rise in the Dax. If this is 10,000 points, each of which is worth 1 euro, a CFD on it would have a total value of 10,000 euros. However, depending on the leverage, you have to pay significantly less. For example, if the leverage is 1:20, you would only have to use 500 euros, i.e. one twentieth of the amount that would have been due for a direct investment. If the Dax now rises to 10,200 points, a profit of 200 euros or 40 percent would result, whereas the profit for a direct investment would have been only 2 percent.

### Are leverage products suitable for beginners?

Short and sweet: **No**. Anyone who invests in leverage products leaves **big risks** because the leverage is fully effective even in the event of a loss. Depending on the product, this can lead to you **Lose all of your invested capital** – or even beyond.

Leverage products are therefore **only for experienced investors**who understand exactly how the investment works and can spare the money they wager. According to the Stock Exchange Act, banks are even prohibited from allowing investors to trade leverage products if they are not familiar with them.

### The alternative for beginners: ETFs

Beginners shouldn’t be lured by the promise of quick profits, but should invest long-term and wisely. That works comparatively comfortably and cheaply with one **Savings plan on an index fund, or ETF for short** (“Exchange Traded Funds). ETFs use a computer algorithm to track a specific stock index, for example the international MSCI World index.

This means that by investing in an ETF, you can invest in the entire global economy with little money. So **spread your risk**because they put it on many different cards at the same time. Now, if you have at least 15 years left, you can **Sit out severe price drops**.