German retail products: warrants (Optionsscheine) and knock-out certificates

What you will learn

• How warrants (Optionsscheine) and knock-out certificates are built and who stands behind them.
• How to use the ratio (Bezugsverhältnis) to calculate intrinsic value and price.
• How to calculate premium (Aufgeld), break-even and leverage for a warrant.
• How the financing level and barrier of a knock-out product work, and why the knock-out can wipe out the position.

Explanation

In Germany, leveraged products are often bought as securities in a normal securities account (Depot). Banks issue them, and they trade on exchanges such as Börse Stuttgart or Börse Frankfurt, or directly with the issuer. The issuer usually acts as market maker: it sets the bid and ask prices, so the spread and the pricing model are controlled by the issuer.

Warrants (Optionsscheine)

A warrant is a securitised option: a call warrant gives the right to buy, a put warrant the right to sell, the underlying at the strike (Basispreis) until or at expiry. In practice it is usually settled in cash. Time value and implied volatility (lesson 5) apply here too. Two new terms:

• Ratio (Bezugsverhältnis): how much of the underlying one warrant refers to. A ratio of 0.1 means 10 warrants = 1 share.
• Premium (Aufgeld): how much more expensive it is to buy the share through the warrant than directly. For a call: premium % = (warrant price ÷ ratio + strike − share price) ÷ share price.

Simple leverage (Hebel) is share price × ratio ÷ warrant price. It shows exposure per euro invested. The more precise measure, called Omega (effective leverage), is simple leverage × delta, because a warrant does not move one-to-one with the share.

Knock-out certificates

A knock-out certificate (also called turbo or Hebelzertifikat) behaves almost linearly: its value is roughly the distance between the underlying and a financing level (Basispreis), multiplied by the ratio. For a long (bull) product: value ≈ (underlying − financing level) × ratio; for a short (bear) product: value ≈ (financing level − underlying) × ratio. Implied volatility plays only a small role.

• The barrier (knock-out level) is the price at which the product ends immediately. If the barrier equals the financing level, it typically expires worthless. If it lies before the financing level, a small residual value may be paid, but in a gap it can be close to zero.
• Open-end products have no fixed expiry. The issuer adjusts the financing level regularly, often daily: upward for long products (you pay financing), and for short products the direction depends on interest rates and the issuer's fee.
• Barriers are often monitored continuously, sometimes also outside the trading hours of the certificate. A brief spike can knock the product out while you cannot trade.

Both products carry issuer risk: if the issuing bank becomes insolvent, you are an unsecured creditor. They are not covered by deposit protection. This is discussed in the next lesson.

Worked example

Hypothetical example: a share trades at €105. Spreads, order fees and taxes are excluded; values are at the mid-price.

Call warrant: strike €100, ratio 0.1, price €1.20.

1. Intrinsic value: (€105 − €100) × 0.1 = €0.50.
2. Time value: €1.20 − €0.50 = €0.70.
3. Price per share via the warrant: €1.20 ÷ 0.1 = €12.00. Break-even at expiry: €100 + €12 = €112.
4. Premium: (€12 + €100 − €105) ÷ €105 ≈ 6.67%. The share must rise 6.67% by expiry just to break even.
5. Simple leverage: €105 × 0.1 ÷ €1.20 = 8.75.

Open-end bull knock-out: financing level €90, barrier €92, ratio 0.1, issuer financing 5% p.a. on the financing level.

1. Value: (€105 − €90) × 0.1 = €1.50.
2. Leverage: €105 × 0.1 ÷ €1.50 = 7.
3. Financing after 30 days: €90 × 5% × 30 ÷ 365 ≈ €0.37, so the financing level rises to about €90.37. If the share stays at €105, the value falls to about €1.46.
4. If the share touches €92, the product is knocked out. Theoretical residual value: (€92 − €90) × 0.1 = €0.20, but the actual payout depends on the price the issuer achieves when unwinding.

Common mistake

Practice activity

Hypothetical: a share trades at €50. An open-end bear (short) knock-out has a financing level of €58, a barrier of €56 and a ratio of 1. Ignore financing adjustments and spreads. On paper calculate: (a) the value of the certificate, (b) its leverage, (c) the value and the percentage result if the share rises to €53, (d) what happens at €56.

Key takeaways

• Warrants and knock-outs are bank-issued securities: the issuer sets prices and you carry issuer risk.
• Always convert the warrant price with the ratio; the premium shows how far the share must move just to break even.
• Knock-out value is roughly the distance to the financing level; touching the barrier ends the product.
• Open-end long knock-outs lose value every day through financing, even when the share does not move.

Next step

In the next lesson you will compare exchange-traded and over-the-counter derivatives and learn to assess counterparty and issuer risk.