A guide to securitised derivatives

Saturday, 10 November 2012 02:41

Securitised derivatives are complex products

Securitised derivatives are complex products

If you have been trading online for some time and feel as though you are ready to branch into a different form of investment, securitised derivatives are one of your options. As these are complex instruments, it is best to only trade them if you have experience.

The following is a brief guide to the securitised derivatives you can trade in, to give you an overview of what is on offer. However, as with any investment you make, their value can fall as well as rise and any income from them is not guaranteed. You should therefore be prepared to lose your investment and always remember that past performance is not a guide to future performance.

What are securitised derivatives?

Securitised derivatives – such as structured products, turbos (formerly known as listed contracts for difference or CFDs) and covered warrants – are leveraged investment instruments, which means a small movement on the markets can result in significant profits or losses.

Each securitised derivative product available to investors will have its own characteristics, and therefore its own risks, so it is important to thoroughly understand what these vehicles consist of and how they are traded.

Due to their potentially volatile nature, securitised derivatives are not suitable for every investor and you should therefore seek independent financial advice if you are at all unsure.

The basics of securitised derivatives

To give you an indication as to the type of investments classed as securitised derivatives, below is a brief description of some of the main instruments available:
• Covered warrants – These are a time-limited investment that provide the investor with the right to buy or sell existing shares at a fixed price before a specified date. They are usually issued by large financial institutions and, as the investor does not take delivery of the underlying asset, they are exempt from stamp duty.
• Turbos – A turbo works in a similar way to a CFD in that it enables you to speculate on the upward or downward movement of the underlying instrument (such as shares, indices or equities) it is linked to. All turbos feature a knock-out barrier at no extra cost to the investor. This means the contract will automatically close if it reaches the knock-out barrier and ensures you can never lose more than your initial stake.
• Traditional warrants – A traditional warrant gives investors the option to buy shares at a fixed price during a specified timeframe. There is no obligation on the part of the investor to purchase the shares, though. A warrant's price will be determined by the value of the underlying instrument, how long it has until it reaches maturity and the exercise price.
• Structured products – This type of securitised derivative will deliver returns – or losses – based on the performance of an underlying instrument, usually a stock market index. They are often customised to meet specific risk-return objectives and, as a result, can include other kinds of derivative, such as swaps, futures and options. Investors can typically lock in gains if the market rises, or limit losses if it falls, with structured products. However, their complex composition means only experienced investors should consider trading in this sort of instrument.

In fact, the complicated nature of all securitised derivatives means investors will be assessed as to their knowledge and experience in financial trading before they are allowed to enter the market. As a result of this and the risks associated with securitised derivatives, many investors may find they are unsuitable for them.

 

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