ubs educational warrants e - ubs-keyinvest · 2 | ubs educational magazine warrants contents 03...

Turning ideas into investments.Seven lessons on leveraged products.

Knowledgein a nutshell

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2 | UBS Educational Magazine Warrants

Contents 03 Lesson 1 Investing with leverage:off to a new dimension!

06 Lesson 2 Shining a light on structured products.

09 Lesson 3 In the derivative shop:a product for every need.

10 Vanilla warrants:the classic way to invest with leverage.

12 Discount warrants:pay fire-sale prices for leverage.

14 Double lockout warrants:Sailing forward without wind.

16 Turbo warrants:shift to a higher gear.

18 Mini futures:leverage the easy way.

20 Lesson 4 Where the winds are blowing.

22 Lesson 5 First steps toward a leveraged product.

24 Lesson 6 Where can I learn more?

26 Lesson 7 What is in a name?

Let’s be honest: most investors feel comfortablewith stocks, bonds and mutual funds, but steerclear of leveraged products. However, leveragedproducts can be attractive, especially where conventional investments offer few options.

Equities, for example, can generate attractive returns over the long term. But their prices do notalways go up and stay up, as the 2008 financialcrisis recently showed. With leveraged products,investors can profit from any expected market scenario – including falling prices. They do notneed to wait for the next bull market. Instead, theycan devise a flexible investment strategy aroundleveraged products.

Small stakes, big impactIn physics, leverage describes the ability to easilylift heavy loads with a lever. The ancient Greeksutilized leverage to build their temples. Even modern-day cyclists make use of it: every turn oftheir pedals propels a relatively large mass usingvery little energy.

Leverage has a similar effect in finance. With relatively little capital, you can achieve largeprice jumps – both positive and negative. Lever-aged products are always based on another asset –the underlying. It might be an equity, preciousmetal, interest rate or currency pair. In otherwords, the leveraged product’s value depends onmovements in the price of the underlying asset.You obtain exposure to the underlying at only afraction of its cost, however.

If an underlying’s price fluctuates by, say, 10 per-cent, the leveraged product’s value can easily riseor fall by several times that amount. Leveragecauses the instrument to respond disproportion-ately to fluctuations in the underlying asset’sprice – both up and down. That also means aformerly profitable investment can quickly shiftagainst you. Only investors who understand thismechanism and can bear the risks should trytheir hand at leveraged products.

Investing with leverage: off to a new dimension!Up, down or sideways: any price movement can generate aprofit with leveraged products – if you know the ground rules.

LESSON 1

UBS Educational Magazine Warrants | 3


Attractive optionsLeveraged products come in various shapes and sizes.Many – but not all – are still built around options. Thisterm comes from the Latin word “optio”, which means“free will” or “free choice”. Options give buyers a rightand thus a choice.

An option buyer acquires the right, but not the obliga-tion, to buy or sell a certain underlying asset at a pre-defined strike price on a particular date in the future.They can let their buying or selling right expire unusedif the underlying asset does not perform as expected during the option’s life.

The choice is entirely up to the option buyer. By contrast,the seller – generally a bank – is obligated to deliver oraccept the underlying asset at the agreed price if thebuyer exercises the option.

There are two standard types of options: calls and puts.A call gives you the right to buy an underlying asset inthe future; a put gives you the right to sell it. A price hasto be paid for either right.

At-the-moneyCalls and puts are at-the-money ifthe underlying asset’s price is equalto the strike price. The option’s intrinsic value is zero. The optioncan still have a value on an ex-change, though: the time value. Itreflects the likelihood that the option will move in the moneyagain.

In-the-moneyA call is in-the-money if the under-lying asset’s price is higher than thestrike price. A put is in-the-moneyif the underlying asset’s price islower than the strike price. In-the-money options have an intrinsicvalue.

Out-of-the-moneyA call is out-of-the-money if theunderlying asset is trading belowthe strike price. A put is out-of-the-money if the underlying asset’sprice is higher than the strike price.Over time, the option may startmoving in the investor’s favoragain.

Securitized options are called warrants. In reality, veryfew options are acquired for the purpose of buying orselling an underlying asset. Many investors either selltheir warrants prior to expiration or settle in cash insteadof in underlying assets at maturity. By selling warrantsprior to expiration, investors can either lock in profits orcut losses.

Varied strategiesLeveraged products are a very diverse group. They pro-vide indirect exposure to many different asset classessuch as equities, currencies, interest rates or preciousmetals. At the same time, they let investors pursue prom-ising strategies in any market scenario. An investor whorecognizes a market trend can make an appropriate playwith leveraged products and earn above-average returnsif the scenario actually occurs – or rack up above-averagelosses if the market moves against him/her. Leveragedproducts can also hedge the downside risk of other in-vestments. Lesson 3 describes how various leveragedproducts work.

See Lesson 4 for details.

On the money


“Insurance” for your portfolio. People insure thethings they value most – from cars to houses. But what about your investment portfolio? How can you insure it against risks in the financial market? Simple – with options.


Leveraged products have a reputation as instru-ments for “gamblers” – is that true?No. First, you should understand how they work. As aninvestor, I can choose to invest directly in equities, goldor currencies or indirectly in a warrant on these under-lying assets. Let’s say I have 10,000 Swiss francs. Insteadof investing this entire amount in a stock, I can spendpart of it on a warrant on the stock. The warrant lets meparticipate through leverage in the stock’s positive per-formance – like buying the stock outright, but with lesscapital. If the stock performs poorly, I lose all of my ini-tial investment in the warrant. In other words, I profit ifprices rise, but – thanks to my option right – only standto lose my option price if prices fall. As a warrant buyer,I am no more a “gambler” than someone who invests directly in the underlying asset.

How could private investors use warrants for hedging?Many investors have a clear view about a company’s

future development, but underestimate how much theoverall market will influence the stock price. Let’s takean investor who is convinced that one particular well-financed company has excellent prospects. They buystock in it. The problem is this: the company could suffer if the stock markets take a dive. After all, everystock harbors not only non-systematic risks – i.e. risksspecific to the security – but also systematic, or market,risks. This systematic risk can be hedged with warrants.For example, you can buy a put on a market index likethe SMI.

Banks quote the buying and selling prices for lever-aged products. Doesn’t that encourage them to justline their own pockets?No. That would not make any sense in today’s warrantsmarket. It is highly competitive and transparent. “And theentry barriers are low”. Large providers cannot affordto skew the bid/ask spreads in their favor. It’s like thecar market. If a dealer asks too much for a used car, he

Shining a lighton structured products.

The history of leveraged products is steeped in misunderstandings. Marc Honegger clears up several of them.

LESSON 2

Marc Honegger,Head Structured Solutions Origination


UBS trading floorsStamford

Sydney

Tokyo

Hong Kong

will have to wait a long time for a buyer. Today, you cancompare prices online with a few clicks. If two banks offer warrants on an underlying with the same terms andthe same strike price, the prices can be compared directlyon the internet.

How important is the bid/ask spread for private investors?If they plan to sell the warrant before it expires, it isvery important. If I am buying a warrant with the in-tention of selling it later for a higher price, I need a nar-row bid/ask spread. A wide spread will cut into myprofits. That is why we try to keep the bid/ask spreadlow for our products. The tightest possible spread isone cent.

Will banks who write warrants also bet against the client’s interests?No. With a leveraged product, clients are buying theright to demand delivery of the underlying asset. To

ensure we can meet this obligation, we take the same position as the client. Here is a simple example: a clientbuys in-the-money call options on a stock for 20 Swisscent each. We hedge our position by buying the stock for10 Swiss francs. That way, we can deliver the stock if theclient demands it at expiration. If the client decides tosell the call prior to expiration because the stock hasgone up, we will finance the profit on the call with thehigher valuation of our equity position. If the stock pricefalls, the client’s call and our stock will lose value. Ourequity position, however, ties up more money than theclient pays in the option price. The client’s maximumpossible loss is the option price of 20 centimes, while wecan lose the stock price of 10 francs. The bank assumesthis risk in exchange for a premium, which is included inthe option price. That said, UBS is a large multinationalbank and so may conceivably hold positions that are opposed to a particular investor’s view of the market.

Opfikon


What should investors look for in a warrantprovider?The issuer should have a good credit rating – every war-rant poses issuer risk. Equally important are the issuer’sproduct range and services after the sale. We deliberatelymaintain a very broad product range. Investors can always find what they are looking for with us. We alsokeep trading liquid and fair at all times. Our clientsshould view us as a partner because we meet their expectations. Only satisfied clients will continue to dobusiness with us.

Other banks want satisfied clients, too.I hope so. Competition is what motivates everyone to im-prove constantly. Very little of the differentiation betweenestablished providers comes from pricing or productranges. Our traders want to serve client needs as com-pletely as possible. We address and take every client

inquiry and complaint very seriously. If you write to us,you will generally get an answer in very little time. And wetraders write the responses, not an anonymous call center.For us, a transaction does not end with the sale of a lever-aged product. We continue to advise and assist investorslong afterwards.

Where can investors educate themselves about warrants? Our products are listed on our Keyinvest website. In-vestors can also subscribe to our warrants newsletter.This is an unusual publication in that the articles arewritten by us, the traders. We present our market assessments, discuss ideas and vividly and succinctly ex-plain how to profit from a particular trend. These are,however, traders’ observations, not investment recom-mendations.

The setting: Hong KongMen, women, young, old – over3500 retail investors surge into theauditorium. They all want to attend a seminar on warrants. Thesponsor is UBS, No. 1 in HongKong, the world’s largest warrantsmarket. As the largest issuer, UBShas listed around 3,000 of thesevehicles on the exchange.

A different cultureMany European investors still feela chill when they hear the word“warrants”. In Hong Kong, any-one with a few Hong Kong dollarsto spare will snap up warrants. Infact, it is considered good form toplay the stock market. Warrantsand Callable Bull/Bear Contracts(CBBCs) account for much of thetrading volume on the Hong KongStock Exchange.

Crowd-pullersJohnny Yu, head of UBS’s warranttrading operations in Asia, has adaily radio show and attracts big-ger crowds than some pop stars. Acardboard owl accompanies himeverywhere. This symbol of wis-dom, speed and reliability is UBS’swarrants mascot in Hong Kong.Here, the distinctive owl is asmuch a part of the bank as thelogo with the three keys.

Curious? Visit UBS’s website in Hong Kong and make the owl’s acquaintance: warrants.ubs.com

Number one with an owl


In the derivative shop: a product for every need.

LESSON 3

You can let your imagination run wild with leveragedproducts. Virtually any asset listed on an exchange canform the core of a promising strategy. But you have toknow what you want. What asset are you eying: an ex-change rate, a precious metal, an equity? Or are youdrawn to interest rates and indexes? What time horizonare you considering? And what extras should be built in?

Investors are in good hands with UBS. It is like being atan open-air market: there is something for everyonehere.

Leverage. Every leveraged product is designed forabove-average upside – but also poses a correspondingrisk.

Liquidity. Investors depend on fair, transparent pricing.That enables leveraged products to be easily bought andsold after issue. In Switzerland, most leveraged productsare traded on the Scoach derivatives exchange.

Issuer risk. Any uncollateralized product issued by abank poses issuer risk. If issuers fail to meet their obli-gations, investors will come up empty-handed. Thatmakes issuer quality a crucial question.

Few asset classes are as varied as leveraged products. They can be out fitted with extra functions depending on the investor’s needs.

The leveraged product line at a glance

Vanilla call andput warrants

Call and put discount warrants

Double lockoutwarrants

Call and put turbo warrants

Long and shortmini futures

Without special functions With special functions

Specific expiration date No expiration date

Price behavior depends Price behavior depends mainly on several influencing factors on the underlying asset


Sooner or later, many experienced investors want to em-ulate the pros by wagering on rising or falling marketsand seizing the opportunity to earn above-average returns on their wagers.

Vanilla warrants, also called “plain vanilla warrants”,are basically the archetype of every geared product thatprovides leverage. They are nothing more than securi-tized standard options without any extras built in. Thereare two basic types of options: options to buy (calls) andoptions to sell (puts).

A right, not an obligationBy buying a call option, you acquire the right to buy(call) a particular underlying asset (equities, currencypairs, interest rates, precious metals, indexes) on or be-fore the expiration date at a pre-determined price (strikeprice). A put option, by contrast, carries the right to sella particular underlying asset on or before the expirationdate at the strike price.

An American-style option lets you buy or sell the under-lying at any time; a European-style option, by contrast,can only be exercised on the expiration date. Thesenames are just categories and say nothing about the op-tion’s geographical origin.

Vanilla warrants The classic way to invest with leverage.

Vanilla warrants are no-frills options. They are ideal for investors who want to bet on a rising or falling market or hedge other positions.


Three properties that you should know

Alternatives. Option holders can choose from severalcourses of action prior to the expiration date. If the priceof the underlying asset moves in their favor, they can sellthe option at a profit or, for an American-style option,exercise it and buy (call) or sell (put) the underlying as-set at the agreed strike price. If the underlying assetmoves against them, they can let the option expire or sellit in the market, where it will fetch a price equal to itsresidual value, if any. The maximum possible loss is theinitial outlay. The amount paid to the option seller is anoption price.

Leverage. Warrants are leveraged investments: investorsparticipate in the performance of the underlying asset,but restrict their stakes to the option price. And the priceis only a fraction of the cost of the underlying asset.Leverage can, however, work in the opposite direction. If the market moves against an investor, they may loseall of their initial outlay.

Influencing factors. Option prices depend on severalvariables: the maturity, the underlying asset and itsvolatility, interest rates and any dividends generated bythe underlying asset. All these factors are used to calcu-late the option price and can affect it positively or nega-tively. Option prices can respond violently to smallchanges in a factor. See Lesson 4 for details.

Your profileYou have a clear view of how theprice of a particular underlying as-set may develop – and when itsperformance will unfold. For thatreason, you want to obtain higher-than-usual exposure to the asset’sperformance. You know that lever-age can quickly turn against you.But you are risk-seeking and cantolerate the complete loss of yourinitial investment.

Your opportunitiesThrough leveraged exposure to ris-ing (call warrants) or falling prices(put warrants), you can earn out-sized profits on movements in theunderlying asset’s price. Theoreti-cally, the upside on calls and putsis unlimited. Puts on equities andprecious metals, however, do havea maximum profit ceiling becausethe underlying assets cannot beworth less than zero. The potentialdownside is restricted to the optionprice. Vanilla warrants can also beused for hedging.

Your risksLeverage inevitably involvesgreater risk since it magnifies bothincreases and decreases in price.Option performance is hard to pre-dict because it depends on a widearray of factors such as maturity,the underlying asset, volatility andany dividends. In the worst case,investors can lose their entire ini-tial capital.

SSPA product category: Leverage without knock-out (2100)

Call and put warrants


Discount warrantsPay fire-sale prices for leverage.

Sometimes the markets show no clear trend and pricesdawdle along at a snail’s pace. In these times, shrewd in-vestors can still skim profits off small price movementsusing discount warrants.

Discount call and put warrants are much like standardoptions. So what is the difference? Discount warrantsare available at discount prices compared to conven-tional warrants. This lower price comes at a cost, how-ever: limited earnings (“cap”). Their prices also behavedifferently from those of vanilla warrants during theirlifetime.

If the underlying assets stay within a fairly narrow cor-ridor, investors can capitalize on price movements withdiscount warrants in much the same way as with con-ventional warrants – except they pay less and so usemore leverage. To generate the same profit with a tra-ditional warrant, the price movement must be muchmore drastic. But be forewarned: discount warrants offer limited upside if the underlying assets fluctuatemore dramatically than expected. In turbulent periods,investors are generally better off with conventionalwarrants.

The “discount” mechanismDiscount warrants utilize a spread strategy. This requiresyou to have a clear image of the underlying asset’s per-formance. Imagine an investor who expects the price of aparticular security to rise 10 percent from 100 to 110. Itmakes no sense to buy a call option that would let himparticipate in any increase in the underlying asset’s pricepast 110. What the investor can do, however, is to sell acall option with a strike price of 110. The sales proceedscan be put towards buying a call option with a strikeprice of 100.

In other words, a spread strategy means you buy one op-tion while simultaneously selling another. With a discountcall warrant, you acquire a call option with a particularstrike price (e.g. 100) and simultaneously sell a call optionwith a higher strike price (e.g. 110). This determines yourmaximum return. With a discount put warrant, you ac-quire a put option at a certain strike price (e.g. 100) andsell a put option with a lower strike price (e.g. 90). Thedifference between the two strike prices is the maximumprofit. A discount warrant embeds this strategy in a prod-uct – investors can acquire it with a single transaction.


Discount. The option prices for discount warrants aremuch cheaper than for vanilla warrants. The upside, how-ever, is limited. The product sells at a discount thanks to anembedded spread strategy.

Spread strategy. You sell a call warrant with a higherstrike price on the underlying asset while also buying acall warrant with a lower strike price on the same un-derlying asset. Since the warrant sale generates income,the discount warrant can be issued at a lower price. Adiscount put warrant takes the exact opposite position.You sell a put warrant with a lower strike price and buya put warrant with a higher strike price.

Influencing factors. The price of a conventional war-rant depends on not only the underlying asset and theoption’s maturity, but also on other factors such as mar-ket volatility. In fact, volatility often has a major impacton warrant prices. Since their upside is limited (“cap”),discount warrants may respond very little – dependingon their remaining lifetime – when underlying assetsswing up above the cap.

In relatively stable markets, discount warrants are a viable alternative to conventional options. Because they are inexpensive, they break evenfairly quickly.


Your profileYou have a clear view of the un-derlying asset’s future performanceover a given period of time. Witha discount warrant, you can gener-ate above-average profits on mod-est projected price movements.However, you should understandhow they work and select the righttarget range for your price expec-tations.

Your opportunitiesYou secure a high upside with asmall amount of capital – eventhough the markets are relativelycalm. Your potential loss is re-stricted to the price paid for thediscount warrant.

Your risksYour upside is limited, and thegearing can vary. Influencing fac-tors such as implied volatility, in-terest rates, maturity and dividendscan affect your investment posi-tively and negatively. As with everyleveraged product, the leverage canalso work against you. Investorscan lose their initial capital.

SSPA product category: Leverage without knock-out (2199)

Discount call and put warrants


Even clever investors run out of ideas when the marketfalls into a lull. But this does not have to be the case.Double lockout warrants were invented specifically forsideways markets.

Despite its complicated-sounding name, this instrumentis very easy to understand. A double lockout warrant hasbuilt-in upper and lower price limits. If the underlyingasset remains within these boundaries without touchingeither one during the term of the contract, you will re-ceive a defined payout on maturity. The tighter the range,the higher the risk for you.

If the price of the underlying asset touches or breachesone of these limits, the double lockout warrant expiresworthless. Investors lose their initial capital.

All or nothingDouble lockout warrants are “all or nothing” instru-ments at maturity. Prior to maturity, though, their valuechanges constantly. A double lockout warrant increasesin price when the underlying asset hardly budges andmoves leisurely between the two limits.

If the underlying asset suddenly takes off and ap-proaches one of the limits, the warrant’s value will in-evitably drop. Implied volatility will also heavily affecta double lockout warrant – but in the opposite direc-tion compared to vanilla warrants. The smaller theprice fluctuations, the less likely it is that the under lyingasset will touch one of the two limits – making the war-rant more attractive. Likewise, the warrant price dropsas volatility rises.

Double lockout warrantsSailing forward without wind.

With a double lockout warrant, you can profit from underlying assetsthat move leisurely within certain boundaries.



Price corridor. The upper and lower barriers representthe core of the double lockout warrant. If the underlyingasset remains within these limits, you can expect to re-ceive a certain sum at maturity. If it touches a barrier, thedouble lockout warrant will expire worthless.

Clarity. The price corridor makes a double lockout war-rant a binary system: either you receive a pre-determinedpayout at maturity, or you do not. There is nothing in

Your profileYou believe that certain assets willmove gently sideways and want toprofit from this. You also expectvolatility to remain low. And youare willing to take on risk.

Your opportunitiesYou can enjoy an attractive upsideeven if the markets show notrends and march in place. Duringthe warrant’s lifetime, you canprofit from rising prices with dou-ble lockout warrants wherevervolatility remains low or evenfalls. At maturity, you receive adefined sum of money as long as the underlying asset did nottouch the upper or lower barriers.

Your risksYour upside is limited. Variablessuch as implied volatility, interestrates, maturity and dividends canpositively and negatively affectdouble lockout warrants. As withevery leveraged product, the lever-age can also work against you. Inthe worst case, where one of thebarriers is breached, investors willlose all of their initial capital.

SSPA product category: Various leveraged products with knock-out (2299)

Double lockout warrants

between. For that reason, investors are well-advised tokeep a close watch on these products and sell them at aprofit at an opportune time – before the underlying assetcomes dangerously close to one of the limits.

Influencing factors. Like conventional warrants, dou-ble lockout warrants are affected by several factors.Volatility, however, has the exact opposite effect onthem. While price fluctuations boost the prices ofvanilla warrants, they lower the value of a double lock-out warrant.


The name says it all: with turbo warrants, investors canturn on the turbo and boost potential returns by a widemargin. They can bet on both rising (call turbos) andfalling (put turbos) markets.

Turbos are less expensive than vanilla warrants and sogenerally provide more leverage. But investors have topay a price for the opportunity to earn higher returns:increased risk in the form of a built-in barrier. Barriersshould never be touched or breached – whether in traf-fic or in turbo warrants. If an investor bets on risingprices by buying a turbo call warrant and the under lyingasset hits or breaches the barrier, the turbo call warrantexpires immediately without value – its term ends pre-maturely.

A turbo put warrant, by contrast, is geared towardsfalling markets. If the underlying asset belies expecta-

Turbo warrantsShift to a higher gear.

Turbos are ideal for betting on an expected market trend. Theirleverage is generally greater thanthat of vanilla warrants – but so is their risk.


tions and moves to or above the barrier, the turbo war-rant has to be written off as worthless.

Leave the ring before the knockoutTurbos can also be traded on an exchange after beingpurchased. That is why investors are advised to watchthe underlying assets’ performance closely and sell theturbo warrants if they come close to a knock-out – ex-piration without value.


Understandability. Turbo warrants mirror the per-formance of their underlying asset almost perfectly. Thismakes them transparent and easy to understand. Thereis one exception, however. There may be price swings ifa dividend is paid for the underlying asset during the lifeof the contract. Implied volatility, which strongly influ-ences the price of other warrants, does not affect turbowarrants.

Barrier. Turbo warrants have built-in barriers. These aregenerally fixed with the strike price and determine thegearing. The strike price and barrier are below the cur-rent market price for turbo call warrants and above itfor turbo put warrants. If an underlying asset touchesthe defined price barrier, the turbo warrant expiresworthless. Investors lose their initial capital, and theirparticipation in the underlying asset ends abruptly. Although the barrier increases the risk of loss comparedto vanilla warrants, it also brings down the price of theturbos – which in turn leads to greater leverage.

Leverage. The closer the strike price and the barrier areto the underlying asset’s current price, the cheaper theturbo warrant and the greater its leverage. However,turbo leverage works in both directions. A greater upsidealso means an increased risk of loss.

Your profileDo you have a clear opinion of themarket and want to profit from it?If you fit this profile and are alsorisk-seeking, you can use turbos inall kinds of strategies. You can, forexample, hedge an equity positionwith turbo put warrants, or youcan bet on rising or falling prices.

Your opportunitiesTurbos produce great leverage.You can bet on certain pricemovements or efficiently hedgeagainst them in any market condi-tions. The fact that volatility doesnot affect pricing is helpful andthe reason why turbos reflect theunderlying asset’s price perform-ance in a transparent and mostlylinear way.

Your risksGearing can vary considerably.And if the underlying asset hits thebarrier, turbo warrants expireworthless. Investors lose all of theirinitial capital. For that reason, theyare advised not to buy any turbosthat are trading close to the barrierand to closely monitor instrumentsafter purchase.

SSPA product category: Knock-out warrants (2200)

Turbo call and put warrants


Most investors are fascinated by the idea of getting moreout of price movements. Some, however, shy away fromwarrants because they consider their mechanism to betoo complex.

The good news is that with mini futures, the latest addi-tion to the leveraged product family, you can invest withleverage the easy way. A mini future’s performance is rel-atively easy to understand because it moves in tandemwith the underlying asset. You can bet on rising priceswith long mini futures and on falling prices with shortmini futures.

Minis for maximum effectHow do mini futures provide leverage? Investors have tofinance only a small portion of the underlying assetthemselves. The issuer of the mini futures handles the re-maining amount – the “financing level”. If, say, the un-derlying asset of a long mini future appreciates signifi-cantly, investors will earn above-average profits. Thehigher the financing level, the greater the leverage. Butborrowing money also costs interest. The issuer chargesthe investor for the financing costs by adjusting the fi-nancing level on a daily basis.

The name “mini futures” reminds us that these instru-ments operate much like futures contracts, but with un-limited maturities.

Mini futures may be easy to understand, but you can easily get burned if the prices start moving against you.Mini future investors should be risk-seeking.

Mini futures Leverage the easy way.

With mini futures,investors can obtain full exposure to theunderlying asset, but they only invest a fraction of it.



Financing level. Mini futures provide leverage by onlyrequiring investors to pay a small fraction of the price ofthe underlying asset. The issuer contributes the rest. Thecloser the financing level is to the price of the underlyingasset, the greater the leverage. The financing level is be-low the current market level for long mini futures andabove this level for short ones. To keep matters simple,the issuer’s financing costs are included in the financinglevel calculations. If the underlying asset hits the stop-loss level, the product is liquidated and any remainingcash is paid out.

No margin call. Unlike conventional futures, the valueof a mini future can never drop below zero. Investorsnever have to put up additional money because these in-struments feature an automatic loss control function: the

stop-loss level. The mini future expires if the under lyingasset moves against the investor and reaches the stop-loss level. In this case, the issuer calculates the remainingvalue and disburses it to the investor – provided it is notzero. The stop-loss level is set slightly higher than the fi-nancing level for long mini futures and slightly lower forshort ones. The level limits the downside risk and pre-vents a margin call. It should not, however, be confusedwith capital protection.

Transparency. The pricing of mini futures is simple andclear. Their performance tracks the underlying asset on aone-to-one basis. The percentage increase is greater,however, since you actually invested less in a mini future.A mini future’s current value is calculated as the differ-ence between the financing level and the underlying as-set’s price level. Factors that typically influence options –volatility, maturity, dividends, etc. – have no bearing onmini futures.

Your profileYou have a clear opinion of themarket and want to bet on a cer-tain price development. You arewilling to take on enough risk. It iseasier to understand the price cal-culations for mini futures than foroptions. For you, mini futures area useful alternative because theymirror the movements of the underlying asset in a linear andtransparent way.

Your opportunitiesMini futures offer medium to highleverage and allow various strate-gies. Investors can profit fromfalling (short) or rising (long)prices. Yet mini futures are trans-parent and their maturity is notlimited from the start. Generally,the lower the interest rates, thelower the cost of the interestcharged for the financing level.

Your risksGearing can vary considerably.The financing level and stop-lossmark are updated constantly. If theunderlying asset reaches the stop-loss mark, mini futures expire im-mediately, and only the remainingvalue is paid back – provided it isnot zero. Investors can potentiallylose all of their initial capital.

SSPA product category: Leverage with knock-out (2210), special characteristic: unlimited maturity

Long and short mini futures

Where the windsare blowing.

LESSON 4

Options form the core of many leveraged products –and are extremely volatile. All the more reason to knowwhat factors affect their value.

Should I sell my warrant now, or should I wait? Beforeyou make this decision, you should know where you areheading. That is not easy: warrants do not embody apossessory claim but a future right that, in turn, refersto an underlying asset. So what determines the value ofa warrant?

The value is made up of two components: intrinsic valueand time value. A call warrant’s intrinsic value takes notime to calculate. It is the difference between the tradingprice of the underlying asset and the strike price. A war-rant only has an intrinsic value if it is in-the-money. Thetime value, on the other hand, depends on a number offactors whose impact can be understood intuitively.



Strike priceIf a call warrant’s strike price is significantly higher thanthe current price of the underlying asset, the warrant willnot really appeal to investors. Its intrinsic value is zero.It would make no sense to exercise the right associatedwith the warrant since the underlying asset can be pur-chased for less on an exchange. It is quite the oppositewith a put. If the strike price is significantly lower thanthe underlying asset’s current price, no sensible investorwill exercise the right to sell – if anything, they will sellthe underlying asset directly and earn a higher return.However, as long as enough time remains until the war-rant expires, the investor can hope that the underlyingasset will move in their favor.

Price of the underlying assetThis is essentially the same concept: if the underlying as-set appreciates, the price of the call soars. The higher theunderlying asset’s current price, the lower the risk asso-ciated with the call. But if the underlying asset fallsthrough the floor, it will drag the call down with it.Leverage has a negative effect in this case. Still, there re-mains a flicker of hope if the warrant’s expiration date isa long way off. Perhaps the underlying asset will recoverto an attractive level. Now, what about the put? Its response is contrary to that of the call: it rises when theprice of the underlying asset drops.

Remaining lifetimeThere is a rule of thumb for both calls and puts: thelonger the remaining “life expectancy”, the longer thesecuritized option is valid and the better the chance thatthe underlying asset will move in your direction. At theleast, the warrant will then have a time value – even ifit is deep out-of-the-money. If, however, the expirationdate is around the corner, the warrant’s actual timevalue is often virtually nil. It is extremely rare for anunderlying asset to make the longed-for price jump atthe very last minute. No matter how positive an impactthe longer maturity may have for the buyer of a warrant –for the issuer, it potentially means a greater liability.

VolatilityThe lifetime factor is linked with implied volatility. Thisrefers to the average fluctuation range expected by mar-ket participants for an underlying asset. The more vio-lently an underlying asset fluctuates, the more likely itwill reach the targeted level at some point. If an under-lying asset hardly budges and is clearly below a call’sstrike price, it is unlikely that the call will go back intothe money. So, if everything moves at a leisurely pace,warrants tend to be less expensive – but boring. Call orput, it does not matter: volatility gives options a boost.

Interest ratesWarrants with longer maturities are especially vulnerableto interest rate changes. You will have to use your imag-ination to understand this: if you buy a call, you canprofit from, say, a currency’s performance. Thanks toleverage, you invest less than with a direct investment.The rest of the money can stay in a fixed income invest-ment. Now, the higher the interest rates, the better offyou will be with your call warrant than with a direct in-vestment. The value of a call option therefore rises as interest rates go up. The opposite goes for a put: its valuedrops if interest rates go up.

DividendsIf a call warrant is on an equity or a share index, changesin expected dividends may affect its value if the term of thewarrant extends beyond the dividend payment. As a war-rant is a deal on the futures market, the expected dividendis factored into the price of the underlying equity. If the eq-uity’s expected dividend increases, the price of the under-lying equity on the futures market and thus the price of thecall warrant sink. This is because warrant holders do notreceive dividend payments. If the expected dividend decreases or lapses completely, the price of the underlyingequity on the futures market and thus the price of the callwarrant rise. The signs are simply reversed for a put.

Influencing factors have a different impact on different instrument types

Vanilla Discount Double lockout Turbo Miniwarrants warrants warrants warrants futures

Underlyingasset High Medium High Very high Very highVolatility High Medium High No impact No impactTime Medium Medium Medium No impact No impactInterest Low Low Low Low MediumDividends Low Low Low Low No impact


Finally, you can look for a leveraged product to suit yourinvestment idea.

2. “Timing is everything”The expected timeframe is a key question for every in-vestment idea. When do I expect the price to move, and byhow much? If an investor is confident that an underlyingasset will take off shortly, they will not need a maturity ofmore than a year. There is no need to pay the premiumfor that. However, if the investor feels unable to make ashort-term forecast but is absolutely convinced that acompany will turn the corner in two years, then the rec-ommended maturity is at least this timeframe.

Leveraged products are not for the risk-averse. Using them requires skill.A step-by-step guide for effectively trading warrants etc.

First stepstowards a leveraged product.

LESSON 5

1. “My view of things”Where are the markets headed? What trends do you see?Anyone who is interested in warrants should form anopinion on the major developments in the financial mar-kets. But that alone is not enough. Investors must alsohave concrete ideas about how to profit from the ex-pected scenario: Which equity might appreciate, and byhow much? Which currency might come under pressure?The possibilities are virtually endless since leveragedproducts can be used to bet on both rising and fallingprices. Next, you should train your sights on the assetsaddressed by your investment idea. Watch their behaviorand set a price target.


3. “A question of price”A leveraged product’s strike price is just as important asits maturity. These two factors determine the characterof the leveraged product and should not be viewed sepa-rately. The strike price should be closely linked to yourpersonal price target. Let’s assume that an investor expects an underlying asset to appreciate from 100 to 110francs within three months. They would be well advisedto set a strike price for a call warrant close to their targetof 110 francs in order to take advantage of the move-ment. They do not need a strike price of 130 francs – eventhough they might gain even more leverage during the lifeof the contract. Note: It is possible to sell warrants at aprofit while approaching the price target. However, if theunderlying closes at or below the price target on expira-tion, the warrant will expire worthless.

4. “Remain vigilant”Geared instruments are highly sensitive to the underlyingasset’s performance and other influences. They moverapidly and violently – and can suddenly take a turn inthe wrong direction. In other words, it takes more thanskill and nerves of steel to invest in a leveraged product.You must also be willing to monitor the market and theperformance of your investments every day and criticallyreview your positions. Hands-off investors, be fore-warned: leveraged products are not for you!

5. “Risk yes, but by design”No return without risk: this is the first commandment offinancial investments. When it comes to leveraged prod-ucts, investors should remember that the higher upsidecomes with more downside risk. If you cannot afford tolose money and do not want “any stress”, you shouldsteer clear of leveraged instruments. After all, not evenexperienced professionals always bet on the right horse.It is therefore extremely important to only spend asmuch money on a transaction as you can afford to lose– even if the markets go south very quickly. Warrants arenot for emotional investors.

6. “Know when to walk away”An old stock market adage says to “cut your losses andlet your profits run”. Hope is a truly bad advisor whenit comes to leveraged products. Experience has shownthat it makes more sense to sell loss-making warrantsand cut losses short than to keep hoping for a miraculousrecovery till the bitter end. Wishing for even higher re-turns may also be counterproductive. It is often better tobring in the harvest before a frost suddenly falls on thestock market. What works well is to set profit targetsand stop-loss limits.


There are thousands of leveraged products on the mar-ket. Every day, some expire and others are added. Eachproduct has different terms, which makes it importantto understand the product’s conditions and risks in detail, and learn how it works.

Term sheet All relevant information about a UBS leveraged productis condensed onto one data sheet: the term sheet. Theseconcise information sheets are available on UBS Quotes,the online financial information system, and on the UBSKeyinvest portal. The Swiss Structured Products Asso-ciation (SSPA) has set minimum information require-ments for term sheets. For instance, the term sheet mustcontain not only the product name but also the producttype according to its SSPA classification. This helpswhen comparing the product to securities from otherproviders – for example, with the “Product finder” toolon the SSPA website: www.svsp-verband.ch

Where can I learn more?

LESSON 6

UBS prepares easy-to-read information with key figures for every lever-aged product it issues. Where to find information and what to look for.


UBS KeyinvestThis UBS portal opens the door to the world of leveragedproducts and all structured products in general for investors. It contains all relevant information and brochures about these instruments – including the termsheets: www.ubs.com/keyinvest

UBS QuotesInvestors can find prices and research on all kinds of in-vestments in the UBS Quotes online financial informa-tion system. To obtain full access to the system – includ-ing real-time prices – they must have an e-banking or online services agreement with UBS. Not only can in-vestors keep an eye on the underlying assets with UBSQuotes, they can also use the “Product finder” functionto find all leveraged products, including new issues:www.ubs.com/quotes

Payoff diagramThe name says it all: this diagram charts the profit orloss an investor can expect when the warrant expires,depending on the price of the underlying asset. The price

of the underlying asset is entered on the horizontal axis,the payoff on the vertical one. UBS has included mostproduct types in the payoff diagram. A note of caution,however: the diagrams are only illustrative and offer noinformation about the actual terms.

UBS warrants newsletterUBS’s warrants newsletter offers a trader commentaryon the market or a selected security twice every week.You can subscribe to the newsletter at: www.ubs.com/swisswarrants

Personal advisory servicesNo investor should have to worry so much about lever-aged product issues that their head starts spinning. Itmakes more sense to contact an expert first – and youwill save precious time to boot. Contact details are in-cluded on every term sheet.

Any other questions?Feel free to write to us right now:[email protected]

Call warrant on AdeccoThis product is a call warrant on a Adeccoshare. The product name will not alwaystell you everything about the product.Many issuers give different names to thesame product type. The products can becompared on the website of the SwissStructured Products Association (SSPA).

Security: 10662480 The securities number is assigned byTelekurs Financial so investors can identifyevery security in Switzerland. The Inter-national Securities Identification Number(ISIN) is used internationally.

SP investment profile: Leverage UBS and the Swiss Structured ProductionsAssociation (SSPA) have developed a clas-sification system for structured products.Each product can be assigned to one offour categories depending on its risk/return profile. Leveraged products belongto the “Leverage” category, which fea-tures not only the highest risk but also thehighest return.

Issuer: UBS AG The issuer issues the leveraged products.Since the issuer is basically a borrower, in-vestors are exposed to issuer risk. That is why the term sheets also include infor-mation about the issuer’s rating.

Type: call, Style: AmericanThis is an American-style call warrant. Un-like European-style warrants, it can be exercised anytime during its life.

Issue price: 0.09 CHFThe issuer issues the leveraged products.Since the issuer is basically a borrower, in-vestors are exposed to issuer risk. That iswhy the term sheets also include infor-mation about the issuer’s rating.

Strike: 72 CHFThe strike price indicates the price atwhich the warrant can be exercised.

Ratio: 20:1It is usually not possible to buy an equitywith a single warrant. The subscription ratio indicates the number of warrants re-quired to buy one underlying asset.

Issue amount: 1,000,000The issue amount means the volume ofthe securities issued. It may indicate thenominal amount or the number. The is-sue volume is calculated by multiplyingthe purchase price by the issue amount.

Payment date: 10/20/2009The product terms are generally not final-ized until the end of the subscription period.

Pricing date: 10/20/2009Key figures such as the strike price are de-fined on this date, and the price of theproduct is determined.

Last trading date: September 17, 2010Last trading date on the exchange.

Expiry Date: September 19, 2009Trading date on which the product expires.

Settlement type: PhysicalThis type of warrant is not settled in cash;instead, the shares are delivered to the in-vestor if they exercise their subscriptionright.

Understanding the key featuresWhat the product features mean


American-style option This type of optioncan be exercised anytime during its life.Since this is convenient for investors, anAmerican-style option costs somewhat morethan its European-style counterpart.

Barrier Barriers always work the same way,whether in traffic or in leveraged products.They should not be hit or, even worse,breached. Barriers are predetermined thresh-olds. There are immediate consequencesif an underlying asset’s price touches orbreaches the barrier: the product is re-deemed prematurely or it expires worthless.

Bear (market) A bear is an investor who ex-pects market rates to fall. Accordingly, theprices in a bear market only know one di-rection: down. This is symbolized by a bearsince these animals swipe their paws downwhen fighting.

Black-Scholes model For many years, thecalculation of a fair option price was a hardnut to crack – until two economists, FischerBlack and Myron Scholes, developed a viable formula some 30 years ago. It is stillbeing used and enhanced to this day.

Bull (market) Do not be offended if youare called a “bull”. Bulls swipe their hornsup in an attack, so this term simply meansyou expect prices to rise. A bull market is amarket where things are looking up.

Call Call also means to “collect” or “de-mand” – which is often more important inbusiness. A call is an option that gives its

holder the right to purchase a specified un-derlying asset at a predetermined strikeprice on or prior to maturity.

Callable bull/bear contract These lever-aged products, “CBBCs” for short, are par-ticularly popular in Hong Kong. They give investors above-average exposure to an un-derlying asset. You can bet on rising priceswith bull contracts and falling prices withbear contracts.

Cap The sky is not the limit for returns oncapped instruments. That is because a capis a defined maximum return. If the under-lying asset begins to soar, investors will onlyparticipate up to the cap.

Derivative As the name implies, derivativesare financial instruments that derive theirvalue from the value of an underlying asset,such as an equity. Examples of derivativesare leveraged products and other structuredproducts.

Derivative map This is the popular term forthe Swiss Structured Products Association’s(SSPA) categorization of structured prod-ucts. The derivative map sorts products intofour categories depending on their risk/return profile. Investors can find the prod-ucts guide on the association’s website. Themap is updated regularly.

Discount Warrants with a discount arecheaper than plain vanilla warrants. Also,because of the cap, they offer more attrac-tive leverage in the expected price range

What isin a name?Financial experts are quite creative when it comes to giving names.Brief explanations of key terms used in the world of leveraged products.

LESSON 7

than vanilla warrants. The discount strategyis attractive whenever the markets do notappreciate much and stay within the ex-pected price corridor.

European-style option A European-styleoption can only be exercised at maturity. Eu-ropean-style options are more widespreadbecause they are generally less expensiveand easier to manage than American-styleoptions.

Financing level Some leveraged products,such as mini futures, operate much like apartially credit-financed investment in theunderlying asset. The borrowed amount iscalled the financing level. The financingcosts for the product are included in the fi-nancing level.

Future Futures are standardized contractsto buy or sell an asset at a future time. Assuch, the quantity and quality of the under-lying asset are standardized and the con-tracts are traded on futures exchanges. Thebuyer of a futures contract is obligated totake delivery of the underlying asset or tosettle in cash on a future date.

Gearing Synonym for leverage.

In-the-money “In the money” means thatthe option has an intrinsic value as well asthe time value. In the case of a call option,the price of the underlying asset is abovethe strike price; in the case of a put option,it is below.


Issuer The bank that issues a leveraged prod-uct is called an issuer. Investors should onlypick issuers with excellent credit ratings.

Knock-out A knock-out or K.O. is rarelypleasant. At least it only has financial con-sequences in options – unlike boxing, wherethe term refers to a temporary loss of con-sciousness. If the underlying asset for theoption type touches a certain barrier, the option expires – it is “knocked out”. The investor loses the money invested.

Leverage Leverage is produced with instru-ments that offer a large upside to investorswith relatively little capital. Leverage alwaysworks in both directions – even against theinvestor. Due to the magnifying effect ofleverage, the price movements are muchgreater compared to the underlying asset.

Long “Going long” means betting on ris-ing prices – either with a direct investmentor a leveraged product. For example, youcan earn outsized profits from rising priceswith long mini futures. A short position, bycontrast, bets on falling prices.

Market maker Market makers agree toquote binding bid and offer prices for lever-aged products on a regular basis. In mostcases, the market maker is the issuer. Even ifthe products are listed on an exchange, it isusually the market maker who ensures theprices are fair.

Maturity Maturity is the life of a financialproduct, from issue to redemption, and isdefined in advance. All relevant particularsare listed in the term sheet and representkey product features. The remaining lifetimeof an option heavily affects the option’s cur-rent price (time value).

Open end Open end products have no life-time restrictions. This does not automaticallymean the products will run forever. For in-stance, a mini future expires if the under -lying asset reaches the stop-loss mark.

Option As Latin speakers know, “optio”means “free will” or “free choice”. As such,options give buyers the right to freelychoose whether to buy or sell an underlyingasset at maturity. The buyers pay an optionprice for this right. Since options can also beused for hedging, the price could also be in-terpreted as an insurance premium.

Option price An option’s price is made upof two components: intrinsic value and timevalue. The option has an intrinsic value if theoption is in-the-money. If the option is out-of-the-money, its intrinsic value is zero. Thetime value depends heavily on the option’sremaining lifetime. The shorter the remain-ing life, the lower the time value. Conse-quently, the option price equals the intrinsicvalue plus the time value.

Out-of-the-money “Out of the money”means that the option does not have an in-trinsic value, but only a time value. In thecase of a call option, the price of the under-lying asset is below the strike price; in thecase of a put option, it is above.

(Plain) vanilla options Unlike exotic op-tions that come with extra features, vanillaoptions – also called plain vanilla options –are conventional, no-frills call and put op-tions. The name comes from vanilla’s mod-ern-day reputation as a common, unexcit-ing flavoring.

Product finder The SSPA provides a “Prod-uct finder” on its website. Investors can en-ter a product’s name in this tool to identifythe product type and find comparable prod-ucts from other providers.

Put The terms of sale for put options arespecified at the very start. Put options givethe owner the right, but not the obligation,to sell the option’s underlying asset at a de-fined strike price at or prior to maturity.

Ratio Latin buffs translate “ratio” as “rea-son”. And, as everyone knows, reason is thebe-all and end-all of investing. When usedwith leveraged products, however, this termrefers to the subscription ratio. It states howmany underlying assets can be purchasedwith a given number of derivatives.

Scoach You will not find this word in anystandard dictionary. It is the name of thestructured products and warrants exchangethat was launched in early 2007. It is a jointventure of the SIX Group and Deutsche Börse.

Secondary market Not all leveraged prod-ucts are listed on an exchange. Most issuers,however, offer a secondary market for trad-ing during the life of the contract. In otherwords, they constantly quote bid and offerprices. For investors that means the second-ary market is not secondary at all; it is ex-tremely important. In Switzerland – on theScoach exchange – trading begins at 9:15a.m. and ends at 5:15 p.m.

Short Investors who “go short” expectprices to fall. They sell their investments oruse leveraged products to bet on fallingmarkets. They can, for example, earn above-average profits from falling prices with shortmini futures. A long position, by contrast,bets on prices rising.

Spread (bid/ask spreads) In the world ofwarrants, a spread denotes the difference be-tween the bid price and the ask price. How-ever, a “spread” can also refer to a differencebetween other securities. Investors can buy aleveraged product at the “ask price” and sellit at the “bid price”. The ask price is alwaysslightly higher than the bid price. The bid/askspread indicates how liquid an asset is.

Spread strategy A spread strategy is em-bedded in discount warrants. It consists ofbuying one option and simultaneously sell-ing another. The sale proceeds from one op-tion reduce the cost of buying the otherone.

Stop-loss mark This function is foundmainly with mini futures. With conventionalfutures, investors sometimes have to meetmargin calls. In other words, they not onlylose their initial investment but have to payin more money. Mini futures do not havethis risk thanks to the stop-loss mark. If theunderlying asset moves against the investorand reaches the stop-loss mark, the mini fu-ture expires prematurely. Investors’ lossesare limited because the residual value is gen-erally paid out to them.

Stop-loss order It is easy to cut losses fromprice drops. Investors simply need to setprice limits that will automatically trigger thesale of the securities. Experience has shownthat investors who do not set stop-loss or-ders often wait out losses for too long.

Strike price The price at which an underly-ing asset is bought or sold when the optionis exercised.

Structured products These financial prod-ucts are made up of different elements, of-ten a fixed income component and a deri-vative. Unlike conventional investments,structured products have asymmetricalrisk/return profiles. They can, for example,come with capital protection functions toprotect investors from price falls. The sameproducts can simultaneously offer attractiveupside potential. Capital-protected productsshould not be confused with leveragedproducts. According to the SSPA, leveragedproducts are in the riskiest category of struc-tured products.

SSPA This acronym stands for the SwissStructured Products Association (SSPA),which was co-founded by UBS. The SSPAworks to increase transparency in the mar-ket and has established a categorization sys-tem for structured products.

Subscription period The period duringwhich potential investors can buy a financialinstrument at indicative terms. The terms arefinalized later, and then the product islaunched.

Underlying Short for “underlying asset”.

Underlying asset The underlying asset isthe basis of a leveraged product. It is the financial asset that a leveraged product islinked to.

Warrants The name given to securitized op-tions in Switzerland. In Germany, they arecalled “Optionsscheine”, or option certificates.

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Publication details

Published by:UBS, Investment Products and Services

Written by: Stephan Lehmann-Maldonado

Layout by:Glutz Kommunikation AG

The information and opinions contained in this publication are solely in-tended for information and marketing purposes and for personal use andare not to be construed as a recommendation to buy or sell any investmentor other specific product. They should not be used as a basis for investmentdecisions. This publication may not be reproduced, in whole or in part, with-out the written permission of UBS.

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