GEARING CAN HELP MANAGE YOUR RISK
ALEXANDRE HOUPERT
HEAD OF LISTED PRODUCTS UK, SG CORPORATE & INVESTMENT BANKING
VOLATILITY is be lower than it was at the end of 2008, but that doesn’t mean that markets are placid. This week’s Japanese GDP data showed that reactions to unexpected news can be extreme.
This is just the kind of market where traders look towards geared products, which allow you to make large gains from proportionately smaller moves in the underlying asset. Traders are aware of the benefits of gearing, but in markets where surprises come thick and fast, they are also keen to limit their potential losses. It’s no surprise, then, that clever traders are looking to to covered warrants, attracted by the fact that – unlike with spread betting – you can never lose more than your initial outlay.
Gearing is also a handy indicator of risk, letting you tailor your trades to your risk-appetite. If you are a risky trader, you would go for a geared covered warrant in a range of 10.0x to 20.0x. The effective rate of gearing is calculated very simply and depends on variables which make it variable: gearing = (underlying asset’s price x delta) / (premium x parity). The underlying asset’s price, the delta and the premium constantly fluctuate. The parity is the only factor that remains constant.
Let’s take the example of a call on the one of Societe Generale’s FTSE 100 covered warrants (SF88), that has delta of 54 per cent, premium of £0.2920, parity of 1000/1 with an index level of 4637.26 points. So if the index increases by 1 per cent, the covered warrant will increase by 8.6x. This is calculated as follows: (4637.26 x 54 per cent) / (£0.2920 x 1,000). This would be good for an investor looking for a medium level of gearing, with a low risk profile. Traders with crystal balls are few and far between. For those who can’t see the future, anything that gives them more control is vital right now.