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How to make money on a turbo option

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For the FTSEthere are three short turbos with three different initial levels, or knock-out barriers, on the underlying index, ranging from 5, to 5, All three expire towards the end of December, how to make money on a turbo option Christmas. Three months is the standard term for a turbo. Each of these turbos sells for a different price. T costs The potential payout and risks attached to each of these turbos is different — they will achieve different outcomes given the same move in the FTSE The potential upside on the cheaper product is much greater than that of the more expensive product.

If the market keeps falling, you'll make much more money from holding the cheaper, more highly geared short turbo T The flipside is that you will lose more money on these more highly geared turbos if the market goes the wrong way, in this case upwards.

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If the market price moves against you and hits the knockout level, your position is closed immediately and you lose the amount you paid for your turbo. You would soon receive a call from the CFD broker demanding that you provide more money on margin to cover your losses. Knowing that you are never going to be exposed to open-ended losses is a key benefit of turbos compared with other derivatives.

Even if the underlying market shoots through the knock-out level, your losses are capped.

What is Turbo mode?

So, the FTSE could surge through a short turbo's knock-out level, right up to, say, But the short turbo simply gets knocked out at What happens thereafter is irrelevant and the losing investor can sleep easy. This sort of guaranteed stop-loss is sometimes available on unlisted CFDs, too — but only in return for an extra payment. With a turbo, it comes as standard, built into the starting price.

how to make money on a turbo option

You should always think carefully about the appropriate knock-out level when taking out a turbo position. The first step is to compare the knock out level with the current price of the underlying share or index.

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If it is very close — just a few per cent away — you could easily find yourself knocked out quickly if the market is very volatile. During the extreme market turbulence of late September and early Octobera number of freshly issued turbos were knocked out shortly after issue, although this is unusual.

In exceptionally violent markets such as these — where the index can move 9 per cent inside a single day — you need to choose a realistic knock out level.

how to make money on a turbo option

The further the price of the underlying is from the knock-out on your turbo, the better. Of course, greater distance from the knock-out level comes at a cost. We've already said that turbo prices reflect all the financing costs, so that there's no need for investors to worry about making calculations from day to day. However, it is still worth understanding the principles that lie behind turbo pricing.

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The process reflects the cost of purchasing access to the underlying asset, such as the FTSE It also contains the costs of financing the position, as well any dividends earned by the underlying asset. The intrinsic value of a turbo is simply its share price minus the strike price.

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So, for a FTSE long turbo with a strike ofwhere the index is trading atwe would say that the turbo has points of intrinsic value. In order words, there's a cushion of points until the turbo hits its knock-out barrier and becomes worthless. Gap risk is the danger that the market will move from one level to another without trading inbetween.

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Let's consider the Glaxo- SmithKline long turbo C, priced at p per turbo at the time of writing — remember, prices can fluctuate enormously with turbos because of their gearing. The financing cost here is based on the strike level ofupon which interest is charged for the life of the contract at a rate based on Libor, an interest rate used by banks to lend to each other.

how to make money on a turbo option

The dividends payable on GSK's shares over the period bring down the cost of financing. The net result after adjusting for interest and dividends is that each turbo costs p. The key thing to remember about turbo pricing is that the 'strike' or initial level for the underlying index or share also doubles as the knock-out level.

The strike is based on prices over the week before the turbo is launched and is structured by the options dealers at SocGen to meet the cost of the margin protection, thereby protecting the investor from huge losses. It is also set at a level so that it doesn't get knocked out easily if the index does suddenly move.

Automatically activate or deactivate Turbo mode

While turbos are designed so that investors aren't exposed to unlimited losses, there are other risks to consider. Turbos are a derivative product and as such you'll have to sign an agreement called a 'warrants or derivatives risk warning and suitability letter' before you're allowed to deal.

how to make money on a turbo option

In the articles that follow, we'll show you the practical uses of turbos — including detailed examples of how you can use them to protect yourself against losses and also how to exploit them to make much bigger gains than you could ever make simply from buying and selling the assets they're based on.

It is how to make money on a turbo option same as the strike level. A long turbo has value as long as the index is above the knock-out level, and a short has value as long as the index is below that level. Each turbo contract lasts three months from the point of issuance. Typical gearing could be anything between five and times.

In the case of five times gearing, a 1 per cent move in the underlying asset will result in a 5 per cent move in the turbo. There are no charges for the index variety of the turbo.

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As with shares, you will always buy at the higher price and sell at the lower price. Usually the spread is not much more than half a penny per turbo. All turbos at 1 October Epic.