What are turbos, options, warrants and futures?

Turbos, options, warrants, options and futures could give your returns an extra boost. How exactly do they work and in what situations might they be of interest? An introduction.

Turbos

What are they?

Turbos are leveraged products that allow you to profit more rapidly from a price movement. You can trade turbos on shares, bonds, commodities, currency pairs and indices.

Why?

Investing offers a high potential return over the long term. Turbos – thanks to their leverage – can be a solution for investors who are also seeking a potential extra return in the short term.

Which type?

You can trade in turbos that anticipate a price rise and turbos that anticipate a price fall. If you think that the price of a share or index will rise, you buy a turbo that is "long" on that share or index. If you expect the price to fall, you will buy a turbo that is "short".

How does it work?

If you buy a turbo on a share, usually you will not only be able to choose between going short or long, but will also be able to choose between various levels of leverage. The higher the leverage, the more the value of the turbo will change if the underlying price changes.

For a long turbo with a leverage of 7, the value of the turbo will rise by 14% if the underlying value (e.g. a share) rises by 2%. If the value of the share falls, the exact opposite applies.

Take the example of a short turbo with a leverage of 10, where the value of the turbo will rise by 10% if the underlying share falls by 1%. If the value of the share rises, exactly the opposite happens.

A turbo does not usually have a fixed expiry date (unlike other leveraged products such as options, warrants and futures), but it does have a stop-loss level. If the price of the underlying asset reaches this stop-loss level, the turbo is terminated. Beyond that you can then no longer trade the turbo.

Who are they for?

Turbos are products that are only suitable for experienced investors who want to take a high risk and who have the time to monitor price movements closely. Although the potential gain is much higher than investing directly in the underlying asset, so is the potential loss. You can lose up to a maximum of your total investment; you may receive a residual value. Turbos are typically products that you keep in your portfolio for just a short period of time.

Options

What are they?

Options are leveraged products that give the buyer the right to buy or sell an underlying asset, at an agreed price, on an agreed maturity date. It is important to remember that the buyer acquires a right to buy or to sell, but it is not an obligation. The underlying asset for an option can be a share, but could also be a currency, bond or index, for example.

Why?

Options are used to protect a portfolio against a fall in prices, i.e. to lock in gains that have already been realised. They are also traded whenever a price rise or fall is anticipated. Options use leverage, which means that the buyer can benefit more rapidly from a price movement.

There is also another route to seeking returns from options, namely by writing your own options (see below).

Which type?

There are two types of options: call options and put options. A call option confers the right to buy an underlying asset, at a previously agreed price (strike price), on an agreed date. A put option confers the right to sell an underlying asset, at a previously agreed price, on an agreed date. The buyer of the option pays an option premium to acquire this right. The seller who wrote (= created) the option receives this premium in exchange for accepting the obligation.

How does it work?

How it works at Keytrade Bank, you can find in our options manual.

In general, if you have a call option, you will only exercise your right to buy when the price of the underlying asset is higher than the strike price. If the price is below the strike price, it is better to buy the underlying asset (such as the shares) directly on the stock exchange.

If you have a put option, you only exercise your right to sell when the price of the underlying asset is lower than the strike price. This allows you to sell your shares at a higher price than on the stock market.

Call options

 Put options

As an investor, you can also write your own options. For example, if you do not expect share X in your portfolio to move much, you can write a call option (covered by your shares). You will then receive an option premium from the buyer, regardless of how the market moves. If the price of the underlying share barely moves, the option will expire as worthless.

All parties need to be able to rely on the obligations being honoured. The bank will therefore always provide a guarantee by blocking the underlying securities or cash on the account. In this way, the trade is covered.

Who are they for?

The prices of options can fluctuate considerably. Options are only suitable for more experienced investors, who are able and willing to take greater risks, and who have the time to monitor their investments. Options can potentially generate a huge return from price rises or falls, but can also lose a lot of money. If you buy options, at worst you can lose your investment. If you are selling options (writing options), your loss may be greater than the option premium you received.

Warrants

What are they?

A warrant gives the right (but not the obligation) to buy (call warrant) or sell (put warrant) a predetermined quantity of an underlying asset at a predetermined price at a stated maturity date. The underlying asset is usually a quantity of shares, but can also consist of currencies or commodities, for example.

A warrant has similar characteristics to an option, such as leverage, but differs in several respects:

• Warrants are issued by companies or financial institutions, options are issued via the options exchange.
• In the case of a warrant, there is one single strike price and one term. In the case of options, there are different strike prices and terms.
• Warrants can only be purchased, not written. For options, either is possible.
• The term of a warrant is generally longer (a few years) than that of an option.

Why?

Companies sometimes issue warrants as part of the remuneration package for their employees. However, you as an investor can also trade in warrants. As with options, warrants use leverage: you can earn a lot from a relatively small amount (you also run the risk of losing a lot).

Which type?

As with options, there are both call warrants and put warrants. A call warrant gives the right to buy the underlying asset at a previously agreed price on an agreed date. A put option gives you the right to sell the underlying asset at a previously agreed price on an agreed date.

How does it work?

If you buy a call warrant and the price of the underlying asset rises above the strike price, you can exercise your warrant to buy the underlying asset at the exercise price (on or before the expiration date).

If you buy a put warrant and the price of the underlying asset falls below the strike price, you can exercise the warrant and sell the underlying asset at the exercise price (on or before the expiration date). Of course, you can only do this if you also have the underlying asset in your custody account. If you do not hold the underlying asset, you can sell the warrant at a profit.

Who are they for?

Warrants work using leverage. As a result, a price movement in the underlying asset may result in a large rise or fall in the price of the warrant. Profits or losses can therefore increase more quickly. At worst, you lose your total investment. Warrants are products that involve greater risks and are therefore only suitable for experienced investors.

Futures

What are they?

Futures are forward contracts in which a buyer and seller fix a price and time in advance at which a certain quantity of an underlying asset must be delivered. This underlying asset can be a commodity, agricultural crop or precious metal, but also financial products.

Why?

Companies can use futures to protect themselves against potential price increases in the future. If the underlying value of the future (e.g. the oil price) rises, the higher cost will be offset thanks to the future. This kind of hedging strategy is of interest to companies, but not so much to investors. They mainly trade in futures in order to seek extra profits. Investors buy futures to make money by correctly estimating future price trends.

How does it work?

A future must be settled at the end of the agreed term. In theory, this can be done through a physical delivery (e.g. of grain, livestock, oil, lead or silver), but as an investor you would probably rather not have these delivered to your front door. Investors therefore sell their futures before the term expires. The difference between the purchase price and the sale price then represents their profit or loss.

With a future, the price of the underlying asset is agreed for delivery in the future. In order to ensure that everything occurs as agreed in the forward contract, guarantees (known as margin) are required to cover the mutual commitments. For this reason, the bank will always hold a guarantee, for example by blocking cash in your custody account. This margin can change due to price movements in the underlying asset, , which means you may sometimes have to provide additional collateral.

Who are they for?

Futures work using leverage. Using a limited amount, you can take a substantial position and potentially earn a lot of money, but you can also lose a lot of money. You may lose more than your deposit. Futures are high-risk products and are therefore only suitable for very experienced investors. Due to their leverage and very long trading hours (23 hours per day), you need to track these products closely.