This article was written in partnership with IG, the world’s No.1 CFD provider (by revenue excluding FX, June 2019). All views expressed in the article are the independent opinion of DollarsAndSense.sg
Earlier this month, we wrote about a new trading product – Knock-outs, which is a type of derivative that traders can use to make trades on a range of products including foreign exchange (Forex) pairs, commodities and indices.
Knock-outs, while not a new product in the financial world, has only recently been introduced to the Singapore market by IG, the leading provider for Contract for Differences (CFDs). Knock-outs are similar to CFDs, only that it has limited risk – since there is an in-built mechanism which automatically closes the trade if the knock-out price level is hit.
Just like any new product in the market, most people, traders included, will have questions in their minds before they think about trading knock-outs. To understand what some of these queries are, DollarsAndSense went down to interview 3 full-time traders who are working at Trading PLC. Trading PLC is a co-working space for traders and investors in Singapore.
Photo Credit: Trading PLC
Chew (C) is in his mid 30s and started trading for more than 10 years ago. As someone who used to work in an investment bank, Chew is familiar with knock-outs as it is similar to a tool that was used for wealth management.
Alex (A), also in his 30s, is an experienced full-time trader who also trades options. He has heard about knock-outs and is familiar with how it works.
Shawn (S) has been trading full-time for a year. Prior to our interview, Shawn admitted that he doesn’t consider himself as someone who is familiar with knock-outs.
DollarsAndSense (DNS): How much do you know about knock-outs?
C: I know about knock-outs as I was previously working in an investment bank and it was a product offered to wealth management clients. My understanding from the product which IG is offering is that it’s a leveraged product, so you can take on a larger position depending on how much leverage you are willing to take.
A: To me, it’s similar to an option but you can only buy the option and not sell it, which means you can’t collect a premium by selling a knock-out. This way, your risk is limited but your upside, potentially unlimited.
S: All I know is that there is some form of guaranteed stop-loss within the product. That’s all.
DNS: Any advantages you see in this product that you like?
C: Compared to a regular Contract For Difference (CFDs), it does look to me as a safer product. This is because 1) you not only have a guaranteed stop-loss in place, but this also allows you to 2) avoid any gap risk, also known as slippage. For example, when trading equities or indices, I am always worried about potential gap risk like the market opening at a price which is already lower than my stop-loss level. With knock-outs, this wouldn’t be a problem.
A: When compared to options, I see two advantages. Firstly, unlike an option, there is no expiry for the trade. As long as the price doesn’t hit the knock-out level, I can choose to remain in the trade. Secondly, for knock-outs, you only pay the premium if the knock-out level is triggered, in addition to the losses incurred. This is unlike buying an option which you have to pay a premium for.
S: I think the biggest advantage is that it has a knock-out level which acts like a guaranteed stop-loss, which helps to limit your losses. I can see how this tool can be useful because your losses are going to be limited but your upside is unlimited. Makes perfect sense if you are swinging for the fences!
DNS: Any concerns about this product that you may have?
C: You pay a premium if the knock-out is triggered. So, when factoring your risk, you must also factor in the premium as this is an expected additional cost you must pay. So, you need to make sure that the premiums you are paying makes sense. It’s like an option, you are paying a premium for protection.
A: Compared to options, you can’t sell a knock-out. This means you can only long or short a position. When you long or short a position, it’s usually quite straightforward. With knock-outs, it makes the trade more complicated. You need to determine your knock-out level, the premiums you need to pay.
S: Using a knock-out means that if a certain trade moves against me and the knock-out is triggered, the overall cost I will be paying, knock-out premium plus actual losses, is going to be higher than if I had made the trade without using the knock-out. So while the knock-out does offer each trade I make additional protection, this also comes with an additional cost. So at the end of the day, as traders, we need to weigh the risk-return trade-off. Is the additional protection we get worth the extra cost incurred?
DNS: Will you personally consider using knock-outs in the future?
C: Firstly, it depends on the premiums. I’m not sure how much premiums they are charging so it’s difficult to say. But to me, it seems like it’s a potential product for swing traders for equities, indices or individual stocks. The biggest concern when trading equities for me is the gap risk, so if the premiums are reasonable, then I don’t mind paying the premium for this protection. But it has to be the right type of trade for the right product.
A: I have an IG account so yes, I might consider using it. It would depend on the premiums.
S: I do have an IG account so for larger positions where I am looking to capture higher profits, or if volatility is expected to be higher, I would consider using it. But it needs to offer what I am looking for in a trade.
Added Protection, Added Premiums
From our conversation with these full-time traders, it’s clear that knock-outs is an additional instrument that most traders would rather have in their toolbox than to not have it. As of today, traders can use knock-outs to trade major forex pairs, stock indices and commodities.
At an additional cost, knock-outs allow traders to make trades that are similar to buying an option, where their downside risk is limited while the upside risk is unlimited. In addition, there is no expiry on the trade as long as the knock-out level is not reached. Also, the knock-out premium is only incurred if the knock-out price level is triggered.
Ultimately, knock-outs is a tool that can be used for trading. It isn’t a strategy on its own and how profitable your trades are going to be, whether you use knock-outs or other tools, will largely depend on your trading strategies.
If you would like to find out more about knock-outs trading, or would like to open a trading account so that you can start trading knock-outs in Singapore, you can open an account with IG today.If you are already an existing IG account user, you should already be able to find knock-out on the IG platform.