This is how short knock-out certificates work – an example
Suppose the DAX is currently at 11,500 points and an investor expects the DAX to fall in the coming weeks with a price target of 11,000 points. The investor identifies the area around 11,600 points as a massive resistance zone and stop. He decides to buy a knock-out put with a strike and an identical knock-out threshold at 11,650 points. The discount that may be encountered in practice is not taken into account in the calculation example.
- Product: Knock-out put on the DAX
- Issuer: XY Bank
- Strike (base price): 11,650 points
- Knockout threshold: 11,650 points
- Subscription ratio: 0.01
- Currency: euros
- Running time: open ended
The price of the knock-out put at the time of purchase is then calculated as follows:
(Strike minus price of the underlying) multiplied by the subscription ratio = (11,650 points – 11,500 points) x 0.01 = 1.50 euros.
For the current leverage at the time of purchase of the knock-out put, the following formula results in a value of: (current price of the underlying multiplied by the subscription ratio) divided by the price of the knock-out put = (11,500 points x 0.01) / 1.50 euros = 76.7.
Thus, the knock-out put would make almost 77 times the DAX, in both a positive and negative direction. In concrete terms, this means, for example: If the DAX falls/rises by one percent, the knock-out put rises/falls by 76.7 percent in the same period. For example, if the DAX falls/rises by two percent, the knock-out put rises by 153.4 percent. If the DAX rose by two percent, the knock-out threshold would be reached and the certificate would fall to EUR 0.00 (total loss of 100 percent).
If the investor’s scenario occurs and the DAX falls to 11,000 points and thus makes a loss of 4.35 percent, the knock-out put would be (11,650 points minus 11,000 points) multiplied by 0.01 = 6.50 in the same time Euro or climb by 333.33 percent.
If an investor were to succeed in buying a knock-out put close to the knock-out threshold (e.g. at a DAX level of 11,630 points in the example) without subsequently incurring a total loss, the leverage would be over 580 ( 11,630 x 0.01)/0.20 is exorbitantly high and the chance of winning is gigantic. If the DAX target price is reached, around 4.4 percent lower than at the time of purchase, a profit of around 2,500 percent would be possible, ie around 25 times the capital invested.