Capital protection products allow investors to gain exposure to stock markets whilst at the same time protecting the capital invested. Typically, these products will be linked to single stocks or indices with a lifespan of 12 to 24 months.

These products are appropriate if you have a reasonably bullish position over the medium/long term but at the same time wish to limit your risk exposure; if the underlying asset appreciates you profit from the performance but if the underlying depreciates, your capital is protected.

Naturally, there is a trade off between the level of upside participation and the level of capital protection afforded. The range of products will offer a choice so you may select a particular underlying and level of protection to suit your expectations and risk profile.

Example:

Underlying: Vodafone

Protection level: 142p

Participation: 50%

Expiry: 16/12/05

Parity: 1

This example is a capital protection product that gives the holder exposure to the Vodafone share price but guarantees to pay out 142p on expiry on 16 December 2005. Should the Vodafone share price close at a level of 142p, the holder will be due 50% of that additional performance.

Scenario 1:

On expiry, the Vodafone share price has fallen to 126p.

Outcome: Protection level of 142p is paid to the investor

Scenario 2:

On expiry, the Vodafone share price has risen to 156p.

Outcome: The investor is paid the protection level plus 50% of the additional performance:

142 + (156-142x50%) = 149p

Parity expresses the quantity of the underlying controlled by each underlying, so the formula to ascertain the value of capital protection instruments is better expressed as:

Expiry value = Protection + (Asset price – protection x participation) x parity

Please note that should the underlying asset be denominated in a foreign currency, there will also be an exchange rate impact that should be taken into account.

Pricing:

These products are constructed using what are called zero-coupon bonds and options. This means that during the lifetime of the instrument, the price will be subject to those factors that influence options, namely:

Underlying Price
Time to Expiry
Expected Volatility
Interest Rates
Expected Dividends

Movements in the underlying price are by far and away the biggest influence on price but the other factors can influence as well. That said, the expiry value is fixed and can be calculated using the formula above.

Advantages:

Risk management through capital protection whilst retaining upside exposure to underlying assets
Continuously traded throughout the lifetime of the instrument
Guaranteed liquidity from 08.15 to 16.30 every trading day
Subject to the rules and regulations of the London Stock Exchange

TURBO & SHORT LEVERAGED CERTIFICATES

Turbos and Shorts allow investors to take a bullish or bearish view on the underlying asset in a similar way to a futures or CFD investment. They replicate the performance of the underlying, but are leveraged investments with an inbuilt stop-loss mechanism.

Key Features

Leverage – rather than paying for the underlying in full, investors pay only the difference in the underlying value and the strike price. The remaining capital required to purchase the underlying (in the case of a Turbo) is borrowed from the Issuer, and the cost of this is built into the price of the certificate Because of the leverage inherent in Turbos and Shorts, percentage movements in the price of the underlying are amplified. As such, investment in these instruments should be considered high risk.
Stop-Loss – leveraged certificates feature an in-built stop-loss mechanism, ensuring the investor’s maximum potential loss is equal to initial capital invested. Should the stop-loss level be breached, the certificate will automatically exercise. Depending on the terms of the security, the Turbo may automatically redeem at zero or alternatively it may retain some intrinsic value at the stop-loss level.

Who would buy Turbos and Shorts?

Leveraged certificates amplify the performance, positive or negative, of the chosen underlying asset. As such, they are designed for those who have a bullish (Turbos) or bearish (Shorts) outlook on the underlying and want small movements in the underlying to lead to large profits/losses.

Example – Turbo (bullish)

With a certificate price of 63p (made up of intrinsic value and interest charge) and a strike price of 3,850, should the FTSE 100 index increase by 5% to 4620 by maturity, the value of the certificate will be 77p (underlying value – strike x multiplier), realising a 22% profit.

If the FTSE 100 index fell by 10% to 3960 after two months, the stop loss level would be in breach and the certificate automatically exercised at 4,000, resulting in a final value of 20p representing the difference between the strike price and the stop-loss level and also taking into account a refund of interest payment to the investor. This amounts to a 59% loss.

Example – Short (bearish)

As the Short gives the right to sell the underlying at the strike price on maturity, it has an inverse relationship to the underlying, meaning that as the underlying decreases in value, the certificate increases. Due to the leverage, a movement of, for example, 1% in the underlying can result in a much greater movement, in percentage terms, of the certificate.

Summary

Turbos and Shorts allow investors to closely replicate the characteristics of a futures or CFD investment, with the additional advantages of the built-in stop loss mechanism, capping losses at the initial investment and increased leverage.

When considering investing in Turbos or Shorts, it is important to keep in mind the high risk involved as a result of the leverage, and to check the exact terms of the certificate, as they can vary between issuers.

You can now trade in over 700 warrants and 20 certificates covering UK and international equities, indices, oil, gold, silver, currency and property.

If you would like further information on these products, please contact Paola Ballarin on +39 02 886 28107.