An introduction to exchange traded products
In this article, we provide a short introduction to exchange traded products, and examine how they differ from more traditional investment products, such as bonds and shares.
What is an exchange traded product?Exchange traded products (ETPs) are instruments that enable investors to trade or invest in an underlying asset. Through ETPs, investors can gain access to an entire index (such as the S&P 500), a single stock, currencies, or commodities, such as gold, silver or oil. ETPs are purchased in single quantities, and they are traded on a stock exchange just like stocks. Investors can see their assets in their account overview with their financial institution.
“We first started seeing ETPs on the Nordic market about 10 years ago,” comments Cecilie Dynkel, Sales Director & Key Account Manager, Nordic Equities & Derivatives at Nasdaq. “It all started with a focus on developing plain, vanilla warrants for the American market, and then we started to see warrants and certificates being issued in the Nordics.”
ETPs on the Danish marketWhen ETPs were introduced to the Danish market, they opened up an investment world previously out of reach for private, experienced investors. “Before ETPs became available, these products were reserved for banks and professional dealers, and therefore inaccessible to private Danish investors,” states Morten Skanning, Senior Product Manager at VP Securities. “ETPs suddenly made it possible for private investors to purchase these instruments through the Danish market infrastructure. This enabled experienced, private investors to access a new range of investment tools.”
The ETPs available on the Danish market typically fall into three categories: bear/bull certificates, tracker certificates and mini-futures. Investors will probably recognise the “bear” and “bull” terms from the stock market, and the same logic applies. Investors purchase bull certificates when they believe that the underlying asset will increase in value; and they purchase bear certificates if they believe the asset will decrease in value.
While ETPs are traded in the same way as stocks, there is one important difference. Some ETPs can be purchased with gearing. “Gearing means that the value of your investment can end up being larger than the amount of money you have actually invested,” says Cecilie Dynkel. “It means you can achieve a higher return on your investment, and that you can gain a much broader exposure to a market with a comparatively small investment.” But the opposite is also true; if the market moves in another direction than expected, the investment value can decrease quickly.
How gearing works: An example
An investor believes an index will increase in value over a period of time and purchases a bull certificate for DKK 100 with x2 gearing. If the underlying asset increases in value by 10%, the certificate will increase by 20% to DKK 120. However, if the underlying asset decreases by 10%, the value of the certificate will decrease by 20% to DKK 80, but the investor can never lose more than the initial investment. Bull and bear certificates are recalculated daily. Gearing can range from x2 to x20 depending on the underlying asset in question.
Please note that this is a simplified example, not taking fees or other product specifications into account.
Short-term vs long-term investment horizons
While investors typically look at stocks and mutual funds as instruments for long-term investments, many regard ETPs as a more short-term investment option. However, it’s really a question of an investor’s investment style and preferences, and the product in question. “It depends a lot on which product an investor wants to trade,” states Cecilie Dynkel. “For example, some products don’t require active management, so you can actually have the position for an extended period of time, without having to monitor it on a daily basis. Others, such as mini-futures, are more active investments. They have a lower investment cost, but require more monitoring.”
The information published in this article should not be considered as advice or a recommendation to buy or sell any financial instrument described herein. There are risks associated with investing in these products. Before making any investment decision, investors should consult their independent legal, financial and/or tax advisors, also in order to check that this investment is appropriate and/or suitable.
To find out more about issuing ETPs via VP Securities, click here.