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TURBO (KNOCK-OUT) CERTIFICATES

Overview:

  • Gains can be realised when prices of stocks, indices or commodities increase or decrease;
  • Instrument with variable leverage;
  • Knock-out mechanism limits losses to invested capital;
  • Instrument for active and experienced investors trading short-term.

List of TURBO certificates available on the WSE

 

Key parameters:

  • underlying – stock, commodity or index on which the certificate "is based". Each Turbo certificate tracks the price of the underlying.
  • direction of investment:

o long certificate – the price of the certificate increases when the price of the underlying increases;

o short certificate – the price of the certificate increases when the price of the underlying decreases;
 

  • barrier – price of the underlying which determines the certificate’s “operating limit.” For a long certificate, the barrier is set below the market price of the underlying. For a short certificate, the barrier is set above the market price of the underlying.
  • knock-out – once the price of the underlying reaches the barrier, trading in the certificate is automatically suspended, the product is delisted, and the investor takes a loss;
  • strike (financing level) – determines the part of the price of the underlying which is financed by the issuer of the certificate. When buying the turbo certificate, the investor “pays” the remaining part of the price of the underlying.
  • leverage – determined on the basis of the market price of the underlying and the strike:
     

o S – spot price of the underlying (e.g., last market price)
X – knock-out certificate strike price
o Long turbo certificate leverage = S/(S-X)
o Short turbo certificate leverage = S/(X-S)
 

  • multiplier – determines the fraction of the underlying represented by one certificate;
  • Turbo certificate price:

o S – spot price of the underlying (e.g., last market price)

X – knock-out certificate strike price

o Long Turbo certificate price = (S-X)*multiplier

Short Turbo certificate price = (X-S)*multiplier

NOTE: Turbo certificates are listed in PLN. The price of those whose underlying is denominated in other currencies than PLN is affected by the corresponding exchange rate.

  • residual value – on knock-out, the issuer sells the basis security and, depending on the market situation, the investor may be paid a surplus of raised cash

 

How does a long Turbo certificate work?

In the example, the investor expects the WIG20 index to rise and buys a turbo certificate with the following parameters:

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Scenario 1 – the market follows the investor’s expectations:

The gross return on the investment was 75% while the price of the underlying increased by 2.3%.

Scenario 2 – the market moves against the investor’s expectations:

Contrary to the investor’s expectations, the price of the underlying decreased. Expecting the trend to change, the investor did not close this loss-generating position. With further decrease, the turbo certificate was automatically “knocked out” once the price of the underlying reached the barrier of 2,183 points. The investor realised a loss of nearly 100% of invested capital (a small residual value can be recovered).

 

How does a short Turbo certificate work?

In the example, the investor expects the price of KGHM stock to fall and buys a turbo certificate with the following parameters:

Scenario 1 – the market follows the investor’s expectations:

The gross return on the investment was 75% while the price of the underlying decreased by 6.2%.

Scenario 2 – the market moves against the investor’s expectations:

Contrary to the investor’s expectations, the price of the underlying increased. Expecting the trend to change, the investor did not close the loss-generating position. With further increase, the turbo certificate was automatically “knocked out” once the price of the underlying reached the barrier of PLN 201. The investor realised a loss of nearly 100% of invested capital (a small residual value can be recovered).


Financing - an "embedded loan"

The barrier and the strike price increase slightly with time. In the long term, this offers additional gains to investors with a short position and a potential loss to investors holding a long position. The changes result from the issuer’s cost of financing.

When buying a leverage certificate on the WSE, the investor “buys” the underlying stock or index at a fraction of the market price. The remaining part is financed by the issuer who buys (or sells) the stock or index futures contract on the WSE against the certificate purchased by the investor. The investor could achieve the same result by taking out a loan from the brokerage house to add to the investor’s own capital invested in purchased securities. However, it is much simpler and cheaper to use a leverage certificate because the investor need not be concerned with the formalities of financing - it is embedded in the certificate, which can be bought simply by placing an order with the brokerage house.

 

Impact of dividend on the Turbo certificate price

The barrier and the strike are reduced by the amount of the dividend attributable to one unit of the underlying. The adjustment is made on the dividend ex-date.
 

Pros and cons of turbo certificates:

 

Disclaimer: Information on structured products is available in the Prospectus and the Final Terms. Before buying any type of structured products, investors should review the legal terms and the product structure described in those documents (they are available in the structured product search engine).

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