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Leonteq Know-How 13What are Warrants with Knock-Out? A guide for private investorsWarrants with Knock-Out are leverage products that allow investors to participate in the price movement of an underlying asset with a comparatively small capital investment. But how do they work, what are their opportunities and risks, and how do they differ from Mini Futures? This article will give you a comprehensive introduction.1. What are Warrants with Knock-Out?A Warrant with Knock-Out is a derivative that is closely linked to the price movement of an underlying asset (e.g. a share, index or currency). There are two main types:

Call Warrant with Knock-Out: Profit from rising prices of the underlying asset.

Put Warrant with Knock-Out: Profit from falling prices of the underlying asset.

In contrast to classic Warrants, Warrants with Knock-Out have a so-called knock-out threshold. If this threshold is reached or exceeded by a price gap, the product usually expires worthless immediately.2. How does a Warrant with Knock-Out work?A Warrant with Knock-Out consists of the following components:

Strike price: Also called strike or financing level. The issuer assumes part of the investment, which means that the investor only has to finance a fraction of the underlying asset. It plays a central role in the pricing and leverage of a Warrant with Knock-Out.

Knock-out level: If this level is reached, the product immediately expires worthless. The knock-out level corresponds to the strike price.

Leverage: The leverage results from the ratio between the current price of the underlying and the current price of the Warrant with Knock-Out.

3. The leverage effect of Warrant with Knock-OutLeverage is a key feature of these products:

Level of leverage: Unlike Mini Futures, Warrants with Knock-Out do not have an upstream stop-loss threshold, which means that the strike price can be placed closer to the price of the underlying asset, allowing for higher leverage.

Dynamics: The closer the underlying is to the knock-out level, the higher the leverage - but also the higher the risk of a total loss.

Calculation: The leverage is calculated using the following formula:

Leverage = \frac{Underlying price [if applicable x exercise ratio x FX]}{Warrant price}

Where FX is the exchange rate between the currency of the underlying and the currency of the product.

Example: An investor buys a Call Warrant with Knock-Out with an exercise ratio of 1 on a share quoted at CHF 100. The strike price is CHF 90, so the investor only invests CHF 10. This results in a leverage of 10 (CHF 100 / CHF 10). The knock-out level corresponds to the strike price and is therefore CHF 90. Possible scenarios:

1. the share rises to CHF 110 (+10%):

The Warrant with Knock-Out rises from CHF 10 to CHF 20 (+100%)
Due to the leverage effect, the gain is disproportionately high.

2. The share falls to CHF 90 (knock-out level reached):

The product automatically expires worthless. If, for example, the underlying opens significantly below the knock-out level on a trading day due to a gap (a price gap), the product expires worthless, but there is no obligation to make additional payments.

Source: Leonteq Securities4. Factors influencing the price of a Warrant with Knock-OutSeveral factors determine the value of a Warrant with Knock-Out:

Price of the underlying: The performance of the underlying has a direct impact on the price of the Warrant with Knock-Out.

Strike price: The closer the strike price is to the current price of the underlying, the more of the investment is financed by the issuer, thus ensuring higher leverage.

Leverage: The higher the leverage, the greater the potential gains - but also the greater the risk of loss.

Financing costs: As the issuer bears part of the investment, ongoing financing costs are incurred, which are borne by the investor through continuous adjustment of the strike price.

5. Opportunities and risks of Warrants with Knock-OutOpportunities:

High profit opportunities: Due to the leverage, even small price movements can generate large returns.

Targeted market strategies: Investors can bet on both rising and falling prices.

Limited capital investment: Only a fraction of the underlying asset is required as an investment.

Risks:

Risk of total loss: If the knock-out threshold is reached or exceeded, the warrant usually expires worthless.

Price gaps: Sudden market movements can trigger the knock-out without warning.

Gap risk premium: Investors pay a fee for the issuer's risk.

6. Differences between Warrants with Knock-Out and Mini FuturesAlthough both products offer leverage, there are some key differences:

Knock-out mechanism: Warrants with Knock-Out expire immediately when the knock-out level is reached, while Mini Futures have an upstream stop-loss level that allows for a possible redemption of the residual value.

Gap risk premium: In the case of Warrants with Knock-Out, the lack of a stop-loss level means that the issuer bears the risk of the underlying falling directly below (call) or above (put) the knock-out level due to a price gap and the issuer being unable to terminate the hedging transaction quickly enough. The issuer therefore charges a gap risk premium, which is included in the product costs.

Leverage: Warrant with Knock-Out can be issued with higher leverage. This is because the lack of a stop-loss level allows for a strike price closer to the current price of the underlying, reducing the entry price.

7. Conclusion: Are Warrants with Knock-Out suitable for you?Warrants with Knock-Out are speculative financial instruments with high profit potential, but also high risk. They are suitable for investors who are aware of the leverage effect and the knock-out problem. If you want to reduce the risk of a total loss, you should consider Mini Futures as an alternative.Tip: Before investing in Warrants with Knock-Out, you should familiarize yourself with the mechanisms and costs and only invest capital that you can afford to lose.Would you like to find out more about Leverage Products? Our team of experts will be happy to help you!

We look forward to answering all of your questions about our products and how they are traded. Please don't hesitate to get in touch! Phone: 058 800 11 11, email info@leonteq.com or contact us here.