Knock-out products: The power of leverage

Greater earnings prospects, higher risk: Knock-out products track price volatility in the underlying asset to an above-average extent.

Four reasons for choosing knock-out products

  • Investors willing to accept risk and with a short-term investment horizon can use knock-out products not only to lock into price movements, but to strengthen them thanks to the leverage the products offer.

  • Higher gains are possible – with a low capital commitment.

  • The price trend is readily transparent.

  • Knock-outs are fungible through Börse Stuttgart from 8 a.m. to 10 p.m.

Winner and loser

How knock-out products work

Knock-out certificates (also called KO instruments or simply knock-outs for short) are securitized derivatives that can be based on a wide array of different underlying assets such as an equity, an index, or a commodity. They expire as soon as a specific knock-out threshold for the underlying asset is reached or exceeded.

Key to any knock-out certificate is the so-called strike price. It defines the intrinsic value of the product. For example, if the underlying equity is at 10 Euros and the strike price is set at 9 Euros, then a knock-out call has the intrinsic value of 1 Euro. In classically structured products the strike price also corresponds to the knock-out barrier: If the price threshold of 9 Euros is reached, then the total capital committed is forfeited.

One major advantage of knock-outs is the transparent development of their price: They match the movement in the underlying asset step by step. If the price of the underlying asset rises by one Euro to 11 Euros, then the price of the knock-out likewise increases by one Euro. This highlights the possible leverage: While the value of the underlying asset climbs by 10 percent, the growth for the KO product is 100 percent, meaning the leverage is a factor of ten.

However, the leverage can also go the other way. Indeed, if your expected movement in the market does not occur, disproportionately large price losses are sustained even prior to the total loss of your investment. For this reason, it is advisable to always keep an eye on the market.

How knock-out products work
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Flexibly fungible through Börse Stuttgart

Knock-out derivatives are speculative products usually intended for a short-term exposure and entailing the risk of a total loss. For this reason, they are primarily suitable for experienced investors prepared to take a risk. From within the broad range of product offerings you can select the strike price and leverage that best fits your risk/return expectations. When it comes to buying a KO product the key is that the closer the knock-out barrier is to the current price for the underlying asset, the greater the leverage and the risk. Knock-out products that benefit from rising prices tend to bear “call”, “long” or “bull” as a prefix. By contrast, KO securities that expect prices to fall are designated as “put”, “short” or “bear” products.

The price of a call KO product with an indefinite period to maturity almost always corresponds to the intrinsic value. Knock-outs also feature a ratio that makes them more cost-effective and thus accessible to a larger number of investors. For example, if the ratio is 10:1, then the product reflects one tenth of its underlying value respectively. Incidentally, in addition to the intrinsic value, you must usually pay the financing costs involved. This is termed the premium.

KO products are the type of securitized derivatives traded most on Börse Stuttgart. A total of 26 issuers offer investors hundreds of thousands of different knock-outs – both with indefinite periods to maturity and with fixed maturity dates. At Börse Stuttgart you can buy or sell them each trading day from 8 a.m. to 10 p.m. In this way, you can also respond to events on exchanges in the USA and Asia.