With turbo certificates (knock-out products), investors use leverage to bet on rising (turbo long certificates or knock-out calls) or falling prices (turbo short certificates or knock-out puts) of the underlying asset. Unlike warrants, the volatility of the underlying asset has virtually no impact on the product’s pricing. The investment horizon for turbo certificates is typically relatively short-term, ranging from a few days to a few weeks.
How do knock-out certificates or turbo certificates work?
Like warrants, turbo certificates (knock-out products) have a strike price that reduces the initial investment and provides leverage on the invested capital. Changes in the value of the underlying asset are tracked at approximately a 1:1 ratio. To avoid a margin call as a retail investor, turbo certificates include a built-in automatic stop-loss barrier, which is set above the strike price for turbo-long certificates (knock-out calls) and below the strike price for turbo-short certificates (knock-out puts). If the price of the underlying asset reaches, falls below, or rises above the barrier at any time during the term, the certificate is terminated. The residual value is determined by the issuer and automatically credited to the investor’s securities account. In the worst-case scenario, the entire invested capital may be lost. Turbo certificates can have either a fixed term or no fixed term (open-end turbo).
1. Turbo-long certificates or knock-out calls
For each turbo-long certificate (knock-out call) sold, the issuer purchases the corresponding underlying asset. Unlike a direct investment in the underlying asset, with a turbo-long certificate, the issuer pre-finances the investor’s investment up to the strike price. These costs are charged to the investor in the form of a premium. In addition, the investor bears the difference between the current price of the underlying asset and the strike price (= intrinsic value). Any dividends are taken into account. The lower capital outlay for the investor compared to a direct investment ultimately results in leverage.
Example
For a turbo long certificate (knock-out call) with a one-year term, where the price of the underlying asset is 100 euros and the strike price has been set at 80 euros and the barrier at 84 euros, the intrinsic value is 20 euros. Assuming a dividend of 2 euros and financing costs of 3 per cent, the Turbo Long certificate would currently cost approximately 20.4 euros (20 euros intrinsic value plus 2.4 euros financing costs minus 2 euros dividend). If the underlying asset has risen to 140 euros by the final maturity date, this results in an intrinsic value of 60 euros and a positive return of 194.12 per cent.
Side note: Turbo-long certificates or knock-out calls with no expiry date
Turbo-Long certificates with no expiry date are usually quoted at their intrinsic value. The financing costs are therefore not offset by a premium, but through regular (usually daily) adjustments to the strike price and barrier.
2. Turbo-short certificates or knock-out puts
For each turbo-short certificate (knock-out put), the issuer sells the corresponding underlying asset. The bank collects the sale price of the underlying asset and invests it. The interest earned is credited to the investor in the form of a coupon payment. In addition, the investor bears the difference between the current price of the underlying asset and the strike price (= intrinsic value). Any dividends are taken into account.
What happens if the barrier is reached?
If the price of the underlying asset reaches or exceeds the barrier even once during the term, the issuer terminates the hedging transaction. The certificate is automatically redeemed at its residual value. The potential residual value is calculated as the positive difference between the strike price and the average settlement price of the hedging transaction.
Redemption of turbo certificates
Turbo certificates (knock-out products) with a fixed term are automatically redeemed at maturity, provided the barrier has not been triggered beforehand. For turbo long certificates (knock-out calls), the redemption amount is equal to the difference between the closing price of the underlying asset and the strike price. For turbo short certificates (knock-out puts), the redemption amount is equal to the difference between the strike price and the closing price of the underlying asset. Turbo certificates with an unlimited term (open-end turbos) are not automatically redeemed as long as the barrier has not been reached; instead, they are redeemed through a sale.
What to consider with turbo certificates
Turbo certificates (knock-out products) offer high profit potential but are also the products with the highest risk among certificates. They are only suitable for investors who closely monitor price movements and are aware of the risk of total loss.
