What are Daily Leverage Certificates

1. Shift Your Trading Performance into Higher Gear

Daily Leverage Certificates (DLCs) are financial instruments issued by a third-party financial institution, usually banks ("issuers"), and are traded in the securities market of the Singapore Exchange (SGX-ST). DLCs offer investors fixed leverage up to 7 times of the daily performance of the underlying asset (e.g. market indices or single stocks). The basic principle is simple – if the underlying asset moves by 1% from its closing price of the previous trading day, the value of a 3x DLC will move by 3%, and that of a 7x DLC will move by 7%.

SGX is the first in Asia to offer trading in DLCs, allowing investors to gain fixed leveraged exposure to the underlying asset such as market indices and single stocks. This comes without the features impacting pricing for options such as implied volatility, time decay or margin calls. DLCs were first introduced in Europe in 2012, where they are also called constant leverage products or factor certificates, and received wide interest from investors in Europe shortly after their launch.

2. Examples of DLCs Listed on SGX

3. Characteristics of DLC

Examples below are for illustrative purposes only and calculations are before cost and fees. The effects of compounding apply to long and short DLCs of all leverage factors(e.g. 3x,5xand7x) and underlying asset, and varies from DLC to DLC.

3.1 Daily Long and Short

DLCs are designed to be traded over short periods of time, predominantly on an intra-day basis. DLCs offer the flexibility to trade both rising and falling markets. For each underlying and leverage factor, there is a long and short DLC available; Buy a long DLC to benefit from rising prices, buy a short DLC to benefit from falling ones.

3.1.1 Example: Daily Long

On Monday the underlying asset closed at a level of 100 and the 3x Long DLC closed at S$2.00 per unit. Assuming the investor believes that the underlying asset is set to rise on Tuesday, he purchased 1,000 units of the 3x Long DLCat a total cost of S$2,000 at the close on Monday. lf at the start of trading on Tuesday, the underlying asset increases by 1% to a level of 101, the value of the 3x Long DLC would have risen by 3% to S$2.06 (before cost & fees) and the 7x Long DLC would have risen by 7% to S$2.14 (before cost & fees). With the potential for enhanced returns, the investor also faces a high level of risk. lf the underlying asset were to decrease by 1% in a day, the value of the3x Long DLC would have decreased by 3% to S$1.94 (before cost & fees) and the 7x Long DLC would have decreased by 7% to S$1.86 (before cost & fees) .

The following illustrative returns are for an investment of 1 unit of the 3x or 7x Long DLC, which was bought at $2.00 and sold within one trading day (before cost & fees).

3.2 Effects of Compounding

3.2.1 Compounding in a Clear Upward Trend

If the investor holds a long position for a week and the underlying asset registers 5 consecutive days of gains, the 3x Long DLC would in fact return more than 3 times the performance of the underlying asset. This is due to the daily rate of the leverage factor. The table below shows that if the underlying asset increases a total of 5.1 % over the 5 days, the 3x Long DLC would increase by 15.9%, which is 3.1 times the performance of the asset (15.9/5.1) and the 7x Long DLC would increase by 40.26% which is 7.9 times the performance of the asset. This disproportionate return is due to the compounding effect. Each day, the previous day's value and gains are again invested with a leverage factor of 3 or 7, as the case may be.

3.2.2 Compounding in a Clear Downward Trend

Conversely, if the investor holds the 3x Long DLC for a week and the underlying asset registers 5 consecutive days of losses, the 3x Long DLC would fall less than 3 times the performance of the underlying asset. In this example, if the underlying asset falls a total of 4.9% over a 5 day period, the 3x Long DLC would fall by a total of -14.1%, which is only 2.9 times the performance of the underlying asset (14.1/4.9) and not 3 times. The 7x Long DLC would fall by 30.4% which is only 6.2 times the performance of the asset. This is again due to the compounding effect of a DLC. Each day the loss is calculated based on a progressively smaller amount.

3.2.3 Compounding in a Sideway Moving Market

The compounding effect of a DLC may not provide favourable returns when the price of the underlying asset moves in a sideways pattern. For example in the table below, the underlying asset registers gains for the first 2 consecutive days but subsequently reverses and loses its previous gains before covering back to the initial level at the end of the 5 days. In this case, the 3x Long DLC would have registered a loss of 1.0% and the 7x Long DLC would have registered a loss of 5.5% at the end of 5 days instead of breaking even. This is why these products are not designed to be traded where the market is moving sideways or to be held for long periods of time.

3.3 Airbag Mechanism

Anairbag mechanism is built into the DLC to slow the rate of loss in the value of the DLC in extreme market conditions when triggered. Each DLC listed will have a pre-set trigger for the airbag mechanism. This trigger is usually activated upon a 10% movement in the underlying index or a 15% movement in the underlying stock of the DLC (based on previous closing price). The airbag mechanism will only be triggered upon movements of the underlying asset that go against the direction of the product. For example, if the underlying stock falls by 15%, (a) the airbag mechanism for a 5x Long DLC will be triggered as the value of the DLC will decrease by 75% (5 x15%); but (b) the airbag mechanism for a 5xShort DLC will not be triggered because with the fall in the underlying stock, this DLC will increase in value by 75% (5 x 15%).

3.3.1 Single Stock DLC Example

Assume an investor bought a 5xLong DLC on Tuesday and the DLC had previously closed on Monday at a price of S$2.00 and the underlying stock closed at S$100. If on Tuesday, by 11.00 am, the underlying stock falls by 15% (from S$100 to S$85), this would translate into a 75% loss on the DLC, leaving it at a price of S$0.50. At this point the airbag mechanism is triggered, the DLC issuer will request SGX to suspend trading in the relevant DLC for 30 minutes from 11.00am to 11.30am and the New Observed Level (NOL) is determined. The NOL is determined as the lowest value of the underlying asset for the Long DLC or the highest value of the underlying asset for the Short DLC during the 15 minutes period after the airbag mechanism is triggered.

The performance of the DLC after the suspension will be based on the NOL. Assuming the NOL equals the airbag trigger point (S$85), if the underlying stock were to fall another 5% after trading resumes at 11.30am, the loss to the DLC would be 25% (i.e. 5 x 5%) of S$0.50 (instead of the previous close of S$2.00), leaving the DLC at a value of S$0.375.

Without the airbag mechanism, an additional 5% fall in the underlying stock would have left the DLC worthless. This is because the total fall of 20% in the underlying stock would result in a 100% loss on the 5x Long DLC if there is no airbag mechanism. However, if the underlying asset were to rebound, the airbag would reduce the investor’s ability to recoup his or her losses as any subsequent gains are now based on the NOL which is a lower value of the underlying asset as compared to the previous day’s closing price.

It is also important to note that the airbag mechanism may not prevent a total loss of investment in the event of a sharp overnight or intraday movement in the underlying asset. Investors should read all listing documents provided by the issuer for the specific airbag mechanism for each product, including the risk factors pertaining to the airbag mechanism.

3.4 Product Specifications

3.5 Investor Suitability

DLCs are for investors who are willing to accept the risk of substantial losses up to the principal investment amount, possibly within a very short timeframe. Investors should also have sufficient understanding of the product and should possess either a high level of knowledge or sufficient trading experience to properly evaluate and assess the product structure, associated risks, valuation, costs and expected returns.

DLCs seek to achieve short-term investment results that correspond to the daily magnified performance of the underlying asset. DLCS are products with features that might be more complex in nature and are only suitable for investors who possess the investment knowledge of more complex products and have a high risk tolerance. Hence, all investors need to be qualified to trade in SpecifiedInvestment Products ("SlP") to be able to trade DLCs. For more information on SlP, visit sgx.com.

Investors are advised to read the listing documents for the relevant DLC before making any investment decision.

3.6 FAQs

Q: How can I trade DLCs?

A: DLCs are currently available on a range of market indices and single stocks. DLCs are listed on SGX and can be traded through a stockbroker in a regular brokerage account. Investors need to be SlP qualified.

Q: Where can l access product prices?

A: You can access prices on SGX website (Securities > Prices & Screeners >Prices), the issuer's website as well as through your stockbroker.

Q: What happens to the DLC when the underlying stock is halted/suspended?

A: Investors should note that if trading in the underlying stock is halted or suspended on the relevant stock exchange, trading in the respective DLCs will be halted or suspended for a similar period.

Q: How would corporate actions on the underlying stock affect the DLC?

A: For corporate actions, the issuer will determine the corresponding adjustment that needs to be made to the DLC in order to preserve economic equivalent. The adjustments to the relevant DLCs will be published on SGX website under "Company Announcements" as well as the issuer's website.

Q: Is my invested capital at risk?

A: Your entire invested capital is at risk. Before trading you should understand the nature of DLCs and the extent of your exposure to risk. In the event the value of a DLC reaches zero/becomes worthless, the issuer may request that the DLC be suspended and subsequently apply for them to be de-listed. Investors should also refer to the other risks listed in the issuer's listing documents which are published under "Company Information" on the SGX website.

Q: What happens at expiry?

A: DLCs have a limited life with a maximum tenure of 3 years. At expiry the final exercised value of the DLC is calculated and automatically paid to investors.

Q: Do l face counterparty risk?

A: Yes, these products are issued by the issuer and may be guaranteed by a guarantor. Any failure of the issuer or guarantor to perform obligations when due could result in the loss of all or part of an investment.

Q: What are the trading cost & fees?

A: Investors trading in and out of a DLC in the same day have to pay a brokerage commission and SGX trading, and clearing fee, and the spread on the bid & ask prices. Overnight positions will incur additional cost charged by the issuer and is reflected in the price of the DLC.