Daily Leverage Certificate (DLC) Shorting SIA Shares Are Now Worth $0
Joel Koh●
Last Wednesday (6 May 2020), Singapore Airlines (SIA) started trading on its ex-rights shares.
On that day, SIA shares rose more than 20%.
Retail investors who bought the 5x Short SIA daily leverage certificate (DLC) saw the total value of their certificates drop to $0.
Yes, you read that right.
As the share price of SIA had appreciated more than 20% from their theoretical ex-rights price (TERP) of $3.71
This TERP was derived by the Société Générale Group (SocGen) a French bank and the issuer of this DLC.
Investors who bought this leveraged product saw losses of more than 100%.
SocGen Singapore Airlines Daily Leverage Certificate Controversy
Investors who bought into the SIA DLCs saw red in more ways than one as there was a significant difference between the SocGen derived TERP and the official SIA TERP.
The SocGen TERP was priced at $3.71 while the official SIA TERP was priced at $4.164.
SocGen’s rationale for this price difference was that:
“Since both the Shares Rights and MCBs Rights may have a dilutive impact on the stock price, in our opinion it was appropriate that both needed to be taken into account for the adjustment [in the TERP].
Furthermore, the TERP could only be determined after market close on 5th May 2020. As such, the adjustment announcement was only published before market open on 6th May 2020.”
However, this was done 22 minutes before the market opened which gave investors very little time to react.
Subsequently, SocGen announced that they will be paying investors of the 5x Short SIA DLC, 30 cents per certificate as a ‘goodwill gesture’
They added that:
“[T]he goodwill payment amount is not intended to compensate investors for all losses, given the risks investors assumed in purchasing these structured products.”
Following SocGen’s adjustment announcement, the Singapore Exchange announced that they have kicked off investigations into this matter.
But you might be thinking: What exactly are DLCs?
As always, we got you!
Disclaimer: The information provided by Seedly serves as an educational piece and is not intended to be personalised investment advice. Readers should always do their own due diligence and consider their financial goals before investing in any stock.
TL;DR: Definitive Guide to Daily Leverage Certificates
Written in a way which shouldn’t put you to sleep.
This guide will cover all you need to know about DLCs, how they work, the risks involved, and what you need to consider if you want to trade them.
- What are Daily Leverage Certificates?
- How do Daily Leverage Certificates Work?
- Risks of Investing in Daily Leverage Certificates
- Are Daily Leverage Certificates Suitable For You?
What are Daily Leverage Certificates (DLCs)?
No, not the downloadable content (DLC) you buy for your game.
DLCs are high-risk financial products issued by market makers like SocGen.
FYI: Market makers are broker-dealer who are prepared to buy or sell a specific security — such as a bond or a DLC — at a publicly quoted price, is called a market maker in that security.
These financial products are structured exchange-traded products that allow investors to take up a leveraged position on an underlying asset like equity indexes (e.g. Hong Kong’s Hang Seng Index) or a single stock (e.g. DBS Group Holdings Ltd (SGX: D05).
DLCs are not new as they were launched in Europe in 2012. They are also known as constant leverage products or factor certificates overseas
The product was first brought over to Asia by the Singapore Exchange (SGX) in 2018.
These certificates are traded on stock exchanges like the SGX; which means you can buy and sell them via your normal brokerage account.
A good thing about DLCs is that there are no margins, no implied volatility impact and no time decay impact. There is also price transparency as the products are traded on the stock exchange.
However, they have a maximum tenure of up to 3 years and will be delisted by the issuer if the underlying asset has lost all its value.
Do note that DLCs are Specified Investment Products (SIP), which means that you might have to have your customer account reviewed before you can trade DLCs.
How do Daily Leverage Certificates Work?
DLCs are structured as short term trades which can be typically settled within a day.
As such, they are not suitable if you have a long term investment strategy.
DLCs are like regular stocks on steroids due to the leverage effect.
DLCs will amplify the performance of the underlying asset in multiples of 3, 5 and 7 times.
This is a double-edged sword as although your returns are amplified, your loses are too.
Types of Daily Leverage Certificates
DLCs come in two flavours; the daily long and daily short version.
If you think the market will rise, buy the daily long DLC. If you think the markets will fall, buy the daily short DLC.
You can buy and sell your DLC on the same day to potentially benefit from a short-term market movement.
Otherwise, you can hold it overnight for potential compounded returns. Do note that your loses will be compounded too along with additional fees and costs.
Daily Reset Feature of Daily Leverage Certificates
DLCs are unique as the price will reset daily based on the price of the underlying asset,
The price of the DLC references the underlying asset the day before will reset at the very start of each trading day.
If you want to hold on to the DLC for more than one day, do note that the value of your DLC will not reflect the price of the underlying asset due to the resets and compounding effects
Thus, you will experience amplified losses due to leverage when the underlying asset price drops for long DLCs or when the underlying asset price goes up for short DLCs.
Conversely, you will sustain leveraged losses when the underlying asset goes down for long DLCs, or when the underlying asset goes up for short DLCs.
What is DLC SGX?
Although DLCs names may look a bit confusing with all the acronyms and numbers, they provide a lot of information on the DLCs.
Here are some examples of the naming convention for DLCs.
Let’s take SIA shares for a real-life example.
On 6 May, SIA shares went up by about 20% after they went ex-rights.
If you bought the 5x SIA DLC, the price of your certificate would have moved either up or down by 100%.
The investors of the 5x Short SIA DLC saw their certificate value drop to zero as they took up a short position on the SIA stock. But SIA shares went the other way.
This leads me on nicely to the risks involved.
Risks of Investing in Daily Leverage Certificates
As with investing there are always risks involved. But here are some risks that are unique to trading DLCs.
Leverage Risk
As seen with the SIA DLC, there are huge leverage risks.
If the underlying asset moves against your DLC, your loses will be multiplied by the amount of leverage you took up.
You could lose a lot more compared to investing directly in the underlying asset.
To invest in DLCs, you will have to be prepared to lose the entirety of your principal amount within a very short time frame.
However, you will not lose more than that.
Air Bag Feature and Risks
To manage risk in extreme market conditions, DLCs have a built-in airbag mechanism which can slow down the rate of exposure during when the market moves in an extreme manner.
This is a special feature of DLCs which cannot be found in other derivative products.
The airbag will be activated when the underlying index or stock moved 10% for a 5x DLC and 20% for a 3x DLC.
When activated, the DLCs will stop trading for 30 minutes and resume with an intraday reset. The price will be reset to a minimum observed level (MOL) which will form the new base level.
This will reduce your exposure to the underlying asset.
On the other hand, the certificate will recover less of its value if the price of your underlying asset rebounds.
Be warned that this airbag feature cannot prevent a total loss of investment as what we saw with the investors of the 5x Short SIA DLC.
If there an extreme overnight fall/rise or steep midday fall/rise of the underlying asset of more than 20% for a 5x DLC, the certificate will become worthless.
Additional Fees
Not to mention that you will have to take into account the following fees:
- Brokerage commission
- SGX trading fee
- Bid and ask spread
- Management fee (if you hold overnight)
- Hedging Premium (cost of hedging if you hold overnight)
- Funding cost and rebalancing cost (charged if you hold overnight)
Are Daily Leverage Certificates Suitable For You?
In my opinion, DLCs are high-risk financial products that need to be considered very carefully.
This is due to their speculative nature and high risks involved when trading them.
They are also short-term trades. If you plan to hold the investment overnight, your gains and losses will be compounded on top of the additional costs and fees you have to fork out.
You will need to have a great tolerance of risk and be prepared to lose all your capital invested as seen with what happened with the SIA DLCs.
Although the returns may seem attractive, it comes with a considerable amount of risk.
If you don’t have a deep understanding of a particular instrument, I would recommend that you stay away.
Stick to things that you know — after all, investing is not a sprint but a marathon.
If you are interested, here’s our guide to investing well over the long term.
Disclaimer: The information provided by Seedly serves as an educational piece and is not intended to be personalised investment advice. Readers should always do their own due diligence and consider their financial goals before investing in any stock.
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