DIY Investor Magazine
/
2015 Issue
10
BOOST YOUR POTENTIAL RETURNS
WHILST LIMITING YOUR RISK
BEN THOMPSON
It’s hard to deny the attraction
of boosting your returns, but
couple it with the threat of
unlimited losses, and many
investors will quickly turn the
other way.
However, trading on leverage does not have to
be at the expense of unlimited losses, as it may
be with CFDs or Spread Bets. It doesn’t even
have to be used in pursuit of bumper returns. It
can in fact be used defensively to reduce capital
at risk, or to provide a degree of protection to a
portfolio.
In this article Ben Thompson – Business
Development Director Societe Generale Listed
Products and Lyxor ETF -looks at what leverage
is, and how you can harness it using regulated
investment products that are listed on the
London Stock Exchange and trade like a share
in a regular stock broking account. Perhaps
most importantly, we will also demonstrate that
with these ‘Leveraged ETPs’ you will never lose
more than you invest.
WHAT IS LEVERAGED TRADING?
Leveraged trading means getting exposure
to an underlying asset without paying the full
cost. Anyone who has bought a house with a
mortgage has done it. Consider an example
where you buy a house worth £300,000 with a
deposit of £50,000 and a mortgage of £250,000.
For £50,000 you have exposure to an asset
worth £300,000.
Theoretically, if your house increases in value by
10% to £330,000 you could sell it, pay back the
bank and pocket the remaining £80,000. That’s
£30,000 more than you invested, and a 60%
profit from a 10% rise in the house price.
In investment terms we call this 6 times gearing
as your profit is 6 times greater than the move in
the underlying asset. Importantly, there is another
lesson to learn. Gearing works against you too. If
the house falls in value to £270,000, your equity
would be slashed to £20,000 as you still owe the
bank £250,000.
INITIAL
PURCHASE
SCENARIO
1: HOUSE
VALUE
INCREASES
BY £30K
SCENARIO
2: HOUSE
VALUE
DECREASES
BY £30K
House
price
£300,000 £330,000
(+10%)
£270,000
(-10%)
Mortgage £250,000 £250,000 £250,000
Invested
capital
£50,000
£80,000
(+60%)
£20,000
(-60%)
BEWARE OF UNLIMITED RISK
Our mortgage example can also be used to
demonstrate a bigger danger. What if your house
fell in value to £225,000? If you sold now you would
not only lose all your invested capital, but you would
have to find an extra £25,000 to pay back your
£250,000 mortgage. In the world of spread betting
and CFDs this is a very real scenario, and your
losses can far exceed your initial investment.
You might argue that a stop loss will protect you
from this situation, and in most cases you would
be right. However, a violent market move, or an
overnight crash in the market can mean that the
market gaps down and the next recorded price is
below your stop loss automatic closing level. If this
happens your loss will be greater than you planned.
NEVER GET A MARGIN CALL AGAIN WITH
LEVERAGE ETPS
The good news is that leveraged returns do
not have to be at the expense of unlimited risk.
Leveraged Exchange Traded Products (ETPs)
enable you to boost your potential returns in rising
or falling markets without ever risking more than you
invest. There are three main types to choose from.
The right one for you will depend on how long you
