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In association with

SG TURBOS

SPECIAL REPORT

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TURBOS: SPECIAL REPORT

BUILDING UP YOUR WEALTH IS A MAJOR CONSTRUCTION PROJ EC T. IF YO U R Eto be a master craftsman rather than a cowboy contra c t o r, you need to have the besttools for the job. A great tool is both simple and ve r s atile. Turbos a speciallydesigned derivat i ve product poss e ss both of these qualities, making them ideal forp r i vate investors and traders to play the marke t s .

Turbos arent nearly as well known as other derivat i ves, such as spread bettingand contracts for difference (CFDs), so in our introductory article on pages 4-6, weexplain what they are and how they wo r k. To see how they perform versus some ofthese other leading tools, we then compare turbos with the competition on page 7.

Nex t, we ta ke a detailed look at some of the main applications of turbos. They arereally handy for protecting the value of your actual shares from short-term dips inthe marke t, as we show in Shelter your assets with turbos on pages 8-9. But theyare equally nifty instruments for raw speculation, thanks to the gearing that they

p o ss e ss, as you'll find out on pages 12-13. Even if your horizons are only a few hours,turbos are great for making big returns without taking undue risks, as JohnHughman demonstrates on pages 14- 1 5 .

Th e r e s no better way to understand the power of turbos than to watch them inaction. Our companies editor, Simon Thompson, has made some hugely profita b l eturbo recommendations this year and, on pages 16- 1 7, he shares some of his ex p e rt-ise in this area.

The Financial Times Limited 2008. Investors Chronicle is a trademark ofThe Financial Times Limited. Financial Times and FT are registeredtrademarks and service marks of The Financial Times Limited. All rightsreserved. No part of this publication or information contained within it may becommercially exploited in any way without prior permission in writing from theeditor. Registered office: Number One, Southwark Bridge, London SE1 9HL.ISSN 0261-3115 Material (including tips) contained in this magazine is forgeneral information only and is not intended to be relied upon by individualreaders in making (or refraining from making) any specific investmentdecision. Appropriate independent advice should be obtained before makingany such decisions. The Financial Times Limited does not accept any liabilityfor any loss suffered by any reader as a result of any such decision.

4 INTRODUCING TURB0STurbos are an ideal tool for private investors whowant to gear up their portfolios and guard againstbig drops in the market.

7 TURBOS COMPA R E DDerivatives share many of the same features, butthere are also important differences between them.

8 S H E LTER YOUR ASS E TS WITH TURBODavid Stevenson shows how you can maintain yourportfolios value using turbos

1 2 SUPER-CHARGED RETURNSTurbos can be used to produce powerful returns thatcomplement the performance of your mainstreamshares and bonds

1 4 TURBO ROUTE TO DAY-TRADING PROFThe gearing on turbos make them great for tra n s f o r m-ing a few hours price movement into big profits, butwithout the ex t reme risk of most other day tra d i n g

1 6 TRADE TURBOS LIKE A PROSimon Thompson reveals how he uses turbos tog e n e rate market-beating re t u r n s

Editorial tel: 020 7775 6582Editorial fax: 020 7775 6501E-mail use: firstname.surname@ft. c o mw w w. i n ve s t o r s c h ro n i c l e . c o . u kI n vestors Chro n i c l eThe Financial Times Business Lt dOne So u t h wark BridgeL o n d o n

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Ma s t e rclass Editor: Dominic PicardaEditor: Oliver Ra l p hDeputyEditor: Rosie Carr Contributors John Hughman,David S tevenson,Simon ThompsonHead of Design: Erica MorganDesigner: LisaSheehanProduction Editor: Victoria ReesDeputy ProductionEditor: Andrew AdamsonSenior Sub-Editor: Kate DisneySub-Editor: Sub-Editor: Sameera Hai BaigEditorial Assistant:Jacqueline BroomeHead of Advertising Sales Dan Churchward020 7775 6596Adve rtising Manager Beth Northey 020 7775 6601Senior Display Sales Executive: David Killick 020 7775 6599Display Sales Executive: Jonathan Haseldon 020 7775 6600Online Sales Ma n a g e r : Brian Cross 020 7775 6598SponsorshipSales Ma n a g e r : Ro b e rtReed 020 7775 6593Head of Production:Denise MacklinDeputy Head of Production: Teresa Kirkpatrick 0207775 6556Publishing Director: Jonathan ChurchManaging Director: Caspar de BonoIllu strations: Ian Whadcock

SPECIAL REPORT 3

Dominic Picarda,Ma s t e rc l a ss editor

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Turbos are an ideal tool for private investors who want to gear up their port f o l i o sand guard against big drops in the marke t. David St evenson and Dominic Picardaexplain the basics and detail the key terms youll need to know

Introducing turbos

WE ALL WANT TOmake the most outof our trading andinvestment ideas.

But, to do so eff e c t i v e l y, we oftenneed a bit of help. Thats wheregearing comes in. Gearing meansthe ability to turn small move-ments in an assets price into bigp rofits. Turbos are a perfect toolfor private investors and tradersto achieve gearing, but withoutmany of the drawbacks andcomplications that come withother geared pro d u c t s .

TURBOS EXPLA I N E DTurbos are specially designedp roducts that are linked to share sand indices. When the re l e v a n ts h a re or index goes up or down,the turbo goes up or down withit but by much more. Forexample, you could buy a turbothat offers gearing of 20 times. If the share it is linked to rises 5 percent, your re t u rn is 20 times that 100 per cent.

Of course, this gearing worksboth ways. When youre right

and the asset goes the way youexpected, you make super- s i z e dp rofits. But when youre wro n g ,you can make big losses. Wi t h

turbos, however, your losses arestrictly limited. Once the pricemoves against you by a cert a i namount, your position is auto-matically closed. Cru c i a l l y, youcan never lose more than you putdown to begin with.

Not only are they less risky thanmany other geared products, butturbos are also much mores t r a i g h t f o rw a rd. They trade on theLondon Stock Exchange and aredealt through stockbrokers, justlike shares, so you can have confi-dence in the prices that you see.

And, despite being a listed pro d-uct, you dont have to pay anystamp duty when you buy them.The costs are all built into the priceyou pay when you buy your turbo there are no charges to pay tokeep the position open, unlikewith some instru m e n t s .

Whether you think an asset isgoing up or down, turbos offer away to make money from yourv i e w. Just as a long turbo makesmoney if the underlying share orindex rises, a short turbo pro f i t sif it goes down. All you have to do

is buy the one that fits your out-look. The ability to speculate onprices falling is valuable, especial-ly in the sort of bearish markets

that weve suff e red in 2008. Thismakes turbos ideal for pro t e c t i n gyour holdings of actual shares, aswell as for speculation.

To understand the key features of turbos, lets look at a list of someleading ones. In the table (above)weve featured the main turbos h o rts off e red for the major equitymarkets as of early October 2008.

It is worth noting that it is stillearly days for SGs re l a u n c h e dTurbo platform. In addition to

these index-based turbos thereis also a small range of individ-ual equity-based turbos. Thesea re tied to Anglo American, BP,

SPECIAL REPORT: TURBOS

SHORT TURBOS

TURBO STRIKE & KNOCKO U T E X P I RY PA R I TY

FTSE 100

T 1 0 3 5 , 5 0 0 1 9 / 1 2 / 2 0 0 8 1 , 0 0 0T 1 0 4 5 , 6 0 0 1 9 / 1 2 / 2 0 0 8 1 , 0 0 0T 1 0 5 5 , 7 0 0 1 9 / 1 2 / 2 0 0 8 1 , 0 0 0

DAX 30

T 1 0 8 6 , 5 0 0 1 9 / 1 2 / 2 0 0 8 1 , 0 0 0T 1 0 9 6 , 6 0 0 1 9 / 1 2 / 2 0 0 8 1 , 0 0 0

CAC 40

T 1 1 2 4 , 5 0 0 1 9 / 1 2 / 2 0 0 8 1 , 0 0 0T 1 1 3 4 , 6 0 0 1 9 / 1 2 / 2 0 0 8 1 , 0 0 0

4 SPECIAL REPORT

Turbos areideal forp r o t e c t i n gyour holdingsof actuals h a r e s

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SPECIAL REPORT 5

GSK and Vodafone, with morescheduled to launch over thenext few weeks and months.

So, how would an investor useone of the index turbos thatappear in the table? For theFTSE 100, there are three shortturbos with three different initiallevels, or knock-out barriers, onthe underlying index, rangingfrom 5,500 to 5,700. All threee x p i re towards the end of D e c e m b e r, before Christmas.Three months is the standardterm for a turbo. Each of theseturbos sells for a different price.T103 costs 39.4p per turbowhile T105 costs 88p.

The potential payout and risksattached to each of these turbosis diff e rent they will achieved i ff e rent outcomes given thesame move in the FTSE 100.The fundamental diff e rence inthe risk/re t u rn profile of eachturbo is the gearing involved.The potential upside on thecheaper product is much gre a t e rthan that of the more expensivep roduct. If the market keeps

falling, youll make much moremoney from holding the cheap-e r, more highly geared shortturbo T103. The flipside is thatyou will lose more money onthese more highly geared turbosif the market goes the wro n gw a y, in this case upward s .

If the market price movesagainst you and hits the knockoutlevel, your position is closedimmediately and you lose theamount you paid for your turbo.Had you held a short position onthe FTSE via a regular contract

for diff e rence (CFD), the potentiallosses could keep on incre a s i n g .You would soon receive a callf rom the CFD broker demanding

that you provide more money onm a rgin to cover your losses.Knowing that you are never

going to be exposed to open-ended losses is a key benefit of turbos compared with otherderivatives. Even if the underly-ing market shoots through theknock-out level, your losses arecapped. So, the FTSE could surg et h rough a short turbos 5500knock-out level, right up to, say,5800. But the short turbo simplygets knocked out at 5500. Whathappens thereafter is irre l e v a n t

and the losing investor can sleepe a s y. This sort of guaranteedstop-loss is sometimes availableon unlisted CFDs, too but only


KEY TERMS

Once theprice movesa gainst youby a certa i na m o u n t, yourposition isa u t o m a t i c a l l y

c l o s e d

in re t u rn for an extra payment.With a turbo, it comes as stan-d a rd, built into the starting price.

You should always think care-fully about the appropriateknock-out level when taking out aturbo position. The first step is toc o m p a re the knock out level withthe current price of the underlyings h a re or index. If it is very close just a few per cent away youcould easily find yourself knockedout quickly if the market is veryvolatile. During the extreme mar-ket turbulence of late September

and early October 2008, a num-ber of freshly issued turbos wereknocked out shortly after issue,although this is unusual.

U n d e r l y i n g : the underlying index or shareyo u re buying exposure to during the three-month term of the contra c t.

S h o rt or long: a short turbo make smoney if the underlying asset goes dow nin value, a long one makes money if itgoes up in va l u e .

Kn o c k-o u t : the pre-determined level atwhich the turbo loses and the inve s t o rs posi-

tion is closed. It is the same as the strike leve l .A long turbo has value as long as the index isa b o ve the knock-out level, and a short hasvalue as long as the index is below that leve l .

E x p i ry: the date in the future when theturbo expires. Each turbo contract laststhree months from the point of iss u a n c e .

Days to ex p i ry : the time left before theturbo ex p i r e s .

G e a r i n g : h ow much the turbos price

will move in response to a change in theunderlying ass e t. Typical gearing could beanything between five and 100 times. Inthe case of five times gearing, a 1 per centm o ve in the underlying asset will result ina 5 per cent move in the turbo.

Ma rg i n : the proportion of the underly-ing index or share that you must put up asm a rgin to pay for the turbo.

Financing cost: the charge per day foreach turbo to finance the contra c t, whichis automatically built in to the turbosprice. There are no charges for the indexvariety of the turbo.

S p read: t h e r e s always a spreadb e t ween the buy and sell price for theturbo. As with shares, you will always buyat the higher price and sell at the lowe rprice. Usually the spread is not muchmore than half a penny per turbo.

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6 SPECIAL REPORT


In exceptionally violent mar-kets such as these where theindex can move 9 per cent insidea single day you need tochoose a realistic knock outlevel. The further the price of the underlying is from theknock-out on your turbo, theb e t t e r. Of course, greater dis-tance from the knock-out levelcomes at a cost. The more inthe money the turbo is, thehigher the likely purchase cost.

Weve already said that turboprices reflect all the financingcosts, so that there s no need forinvestors to worry about mak-ing calculations from day tod a y. However, it is still wort hunderstanding the principlesthat lie behind turbo pricing.The process reflects the cost of p u rchasing access to the under-lying asset, such as the FTSE100. It also contains the costs of financing the position, as wellany dividends earned by theunderlying asset.

LONG AND SHORT TURBOS

Heres a simple breakdown of the structure of the prices of longand short turbos on indices: Long turbo = intrinsic value +gap risk. Short turbo = intrinsic value +gap risk.

The intrinsic value of a turbo is

simply its share price minus thestrike price. So, for a FTSE 100long turbo with a strike of 4500,where the index is trading at4800, we would say that theturbo has 300 points of intrinsicvalue. In order words, theres acushion of 300 points until theturbo hits its knock-out barrierand becomes worthless.

Gap risk is the danger that themarket will move from one levelto another without trading inbe-t w e e n .

For turbos on stocks, the calcu-lation is only slightly different: Long turbo = intrinsic value +fees dividends. Short turbo = intrinsic value +dividends.

L e t s consider the Glaxo-SmithKline long turbo C733,priced at 118p per turbo at thetime of writing (re m e m b e r, pricescan fluctuate enormously with tur-bos because of their gearing). C733 price = GSKs marketlevel strike level + financingcosts dividends.

The financing cost here is based

on the strike level of 1100, uponwhich interest is charged for thelife of the contract at a rate basedon Libor, an interest rate used bybanks to lend to each other. Thedividends payable on GSKss h a res over the period bringdown the cost of financing. The

net result after adjusting fori n t e rest and dividends is thateach turbo costs 118p.

The key thing to rememberabout turbo pricing is that thestrike or initial level for theunderlying index or share alsodoubles as the knock-out level.The strike is based on prices overthe week before the turbo islaunched and is structured bythe options dealers at SocGen tomeet the cost of the margin pro-tection, thereby protecting theinvestor from huge losses. It isalso set at a level so that it does-nt get knocked out easily if theindex does suddenly move.

While turbos are designed sothat investors are n t exposed tounlimited losses, there are otherrisks to consider. Turbos are aderivative product and as suchyoull have to sign an agre e-ment called a warrants orderivatives risk warning andsuitability letter before youreallowed to deal.

In the articles that follow, wellshow you the practical uses of

turbos including detailed exam-ples of how you can use them top rotect yourself against lossesand also how to exploit them tomake much bigger gains than youcould ever make simply fro mbuying and selling the assetst h e y re based on.

ALL TURBOS AT 1 OCTOBER 2008

EPIC CALL OR PUT STRIKE PARITY E X P I RY UNDERLYING ASSET KNOCK-OUT BID AS K SPOT PRICE ON UNDERLYING

T 1 0 3 . L P 5 , 5 0 0 1 , 0 0 0 1 9 / 1 2 / 0 8 F TS E 5 , 5 0 0 0 . 6 5 4 0 . 6 5 7 4 , 9 8 9 . 8 0 5T 1 0 4 . L P 5 , 6 0 0 1 , 0 0 0 1 9 / 1 2 / 0 8 F TS E 5 , 6 0 0 0 . 7 5 1 0 . 7 5 4 4 , 9 8 9 . 8 0T 1 0 5 . L P 5 , 7 0 0 1 , 0 0 0 1 9 / 1 2 / 0 8 F TS E 5 , 7 0 0 0 . 8 4 9 0 . 8 5 2 4 , 9 8 9 . 8 0 5T 1 0 8 . L P 6 , 5 0 0 1 , 0 0 0 1 9 / 1 2 / 0 8 G DA X I 6 , 5 0 0 0 . 7 0 8 0 . 7 1 7 5 , 8 0 5 . 3 5T 1 0 9 . L P 6 , 6 0 0 1 , 0 0 0 1 9 / 1 2 / 0 8 G DA X I 6 , 6 0 0 0 . 7 8 5 0 . 7 9 4 5 , 8 0 5 . 3 5T 1 1 2 . L P 4 , 5 0 0 1 , 0 0 0 1 9 / 1 2 / 0 8 F C H I 4 , 5 0 0 0 . 4 9 1 0 . 4 9 4 4 , 0 3 9 . 6 6T 1 1 3 . L P 4 , 6 0 0 1 , 0 0 0 1 9 / 1 2 / 0 8 F C H I 4 , 6 0 0 0 . 5 7 0 0 . 5 7 3 4 , 0 3 9 . 6 6C 7 2 7. L P 2 , 7 0 0 1 1 2 / 1 2 / 0 8 AA L. L 2 , 6 0 0 7. 7 5 9 7. 8 0 9 1 , 9 2 3 . 0 0C 7 2 8 . L P 2 , 8 0 0 1 1 2 / 1 2 / 0 8 AA L. L 2 , 7 0 0 8 . 7 5 9 8 . 8 0 9 1 , 9 2 3 . 0 0C 7 3 2 . L P 5 4 0 1 1 2 / 1 2 / 0 8 B P. L 5 3 0 0 . 6 9 7 0 . 7 1 7 4 6 9 . 5 0 5C 7 3 3 . L C 1 , 1 0 0 1 1 2 / 1 2 / 0 8 G S K. L 1 , 1 5 0 1 . 2 7 9 1 . 3 3 9 1 , 2 1 2 . 5 0C 7 3 4 . L P 1 , 3 2 0 1 1 2 / 1 2 / 0 8 G S K. L 1 , 2 8 0 1 . 0 4 8 1 . 1 0 8 1 , 2 1 2 . 5 0C 7 3 9 . L C 1 0 5 1 1 2 / 1 2 / 0 8 VO D. L 1 1 5 0 . 2 0 8 0 . 2 2 8 1 2 5 . 0 0C 74 1 . L P 1 5 0 1 1 2 / 1 2 / 0 8 VO D. L 1 4 0 0 . 24 0 0 . 2 6 0 1 2 5 . 0 0C 74 2 . L P 1 6 0 1 1 2 / 1 2 / 0 8 VO D. L 1 5 0 0 . 3 4 0 0 . 3 6 0 1 2 5 . 0 0Source: SocGen

The costs areall built intothe price youpay when youbuy yourturbo, unlikewith some

i n s t r u m e n t swhere youhave charg e sto pay tokeep theposition open

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SPECIAL REPORT 7


D e r i vat i ves share many of the same features, but there are also importantdifferences between them. Dominic Picarda explains why you might wantto employ turbos rather than one of the alternat i ve s

Turbos compared

YOURE SPOILT FORchoice when it comesto trading derivativesnowadays. The selec-tion is wide and growing all thetime. Spread betting, contractsfor diff e rence (CFDs) , stru c-t u red product s, futures andoptions are all readily avail-able. So how do turbos re l a t eto these other products andwhy might you choose themover the others?

The idea of investing in turbos rather than the actual share sor indices that theyre linked to is to obtain gearing. Most of the other popular derivativespossess this quality, too.H o w e v e r, with turbos you cannever lose more than your initialinvestment. This is not the casewith spread bets, CFDs orf u t u res, although it is a featureof fixed-odds financial bettingand purchased options.

Turbos trade on the LondonStock Exchange, like ordinaryshares, and are bought and soldthrough stockbrokers. However,unlike shares, you dont have topay stamp duty upon purchase.This makes them par t i c u l a r l ysuitable for getting in and out of markets quickly and at low cost.You dont pay stamp duty onunlisted CFDs either, but yourlosses are potentially unlimitedwith these products.

Because they trade on a re g u-lated stock exchange, turbosprice s are very transp are n t .

You can consult these prices aseasi ly as you would ord i n a rys h a res. The price of the assetsthat they are linked to is alsothe real market price. This isd i ff e rent from spread bett ing,w h e re the prices are mere l ybased on market prices, withthe effect that stop-losses canbe triggered even though thereal market price never hit thespecified level.

Because they are an actual list-ed investment product, pro f i t son turbos are subject to capitalgains tax, just like profits onCFDs, futures and options, andactual shares. The only pro d-ucts that avoid capital gains taxa re spread bets and fixed-oddsfinancial bets, as these are clas-sified as wagers rather thaninvestments.

If youre looking for a pro d u c tto hedge actual shares, turbosmake better sense than betsbecause profits and losses onturbos and shares are subject tothe same tax treatment. So, if you lose on your turbo, you willbe able to offset your short f a l lagainst p rofits on your share sand vice versa, which youc o u l d n t do with a bet.

What turbos are really is listedCFDs contracts for diff e re n c ethat trade on an investmentexchange. Turbos also comewith inbuilt protection in thef o rm of an embedded knock-out barr i e r. When the price of the underlying asset hits that

stop-loss level, the position clos-es automatically and theinvestor loses his investment,but nothing more. With anunlisted CFD, it is up to theinvestor to specify a stop-lossand there is an ex tra cost to pay.And if the underlying price goesa long way through that stop-loss, he is liable for whateverlosses ensue, even if they aremuch greater than the amounthe started out with.

Both unlisted CFDs and tur-bos are mainly used fors h o rt - t e rm purposes. However,an unlisted CFD has no auto-matic expiry date, where a sturbos generally speaking havea set l ife of three months fro mthe moment they are issued.Unlisted CFDs do offer expo-s u re to a much broader range of underlying assets, includingmany individual equities, bothdomestic and foreign, as well asto currencies, bonds and com-modities. Over time, though,the range of turbos on offer islikely to expand.

Turbos share similarities withanother stru c t u red pro d u c tcalled covered warrants. Whilethese are also issued in theUK by Socit Gnrale, therea re key diff e rences betweenthem. Covered warrants off e rmuch greater variety when itcomes to expiry dates. You canbuy covered warrants thate x p i re 12 months from now, forexample.

K E YP O I N TS The idea ofi n vesting in turbos rather thanactual shares orindices that theyr el i n ked to is too b tain gearing

Turbos trade onthe London stockm a r ket and arebought and soldthrough stock-b r o ke r s

Because theyt rade on ar e g u l ated stockexchange, turbosprices are ve ryt ra n s p a r e n t

You can neve rlose more thanyour originali n vestmentwith turbos

007_ICSG_1710_TurbosCompared 21/10/08 16:26 Page 7

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8 SPECIAL REPORT

D ra m atic moves in financial markets are much more common than yo u db e l i eve. David St eve n s o n s h ows how you can maintain your port f o l i os valueusing turbos

Shelter your assetswith turbos

FINANCIAL MARKETScan be a very scaryplace, as we all know alltoo well after the tur-

moil of the past 18 months.Over the long run, developed-

market equities have proved asafe bet. Theyve massively out-p e rf o rmed other leading assetclasses, like corporate or govern-ment bonds and cash deposits.But superior re t u rns come onlyat the cost of higher risk, in this

case: volatility.The chart (right) depictsvolatility for the Dow Jonesindex over two decades. It showsthe range of re t u rns achievedf rom investing in this benchmarkUS index over that period.Conventional theory suggeststhat re t u rns over time will be dis-tributed in a fairly even pattern ,with extreme events occurr i n gonly very rare l y.

A study by FinAnalytica, aninvestment re s e a rch firm, suggeststhat in any real-life distribution of

re t u rns, extreme events are actu-ally much more common than wethink. The chart shows a worry-ingly large number of spikes d o w n w a rd spikes indicate biglosses. FinAnalyticas analysissuggests that extreme events hap-pen, on average, every 233 daysover the long term, or more thanonce a year.

Even if youre a long-term ,buy-and-hold investor who feelshe can ride out any near-termvolatility, it pays to take out

insurance against the downside.Many people respond to turbu-lence by simply switching fromshares into cash. However, hav-ing to sell your shares in thisway is often not an ideal solu-tion, as it involves incurr i n gstamp duty, brokers commis-sions and capital gains tax.

A more sophisticated a p p ro a c his to use derivative products tohedge your holdings of sharesand other assets. So, when your

equities, bonds and commodi-ties lose money, your derivativehedges make profits, cancellingeach other out. And in a longperiod of falling markets suchas 2000-03 you can also makepositive returns from speculat-ing on market declines.

A BEAR MARKETHEDGE FUNDTo understand how you couldhedge your portfolio, well takeone simple example a bearishstrategy on the FTSE 100.

Say the index is trading at 4900,having fallen from a peak of 6750in 2007. However, you maybelieve that it is due anothers e v e re correction. You dontknow where the bottom willo c c u r, but you think its a longway from current levels. You holda portfolio of shares and fundsw o rth 10,000 5,000 of whichis exposed to the FTSE 100 withthe rest in bonds, cash andvolatile emerging market equities.

The first step is to work out

how much youre willing to payfor protecting your port f o l i o .P e rhaps you feel the market is atrisk of a 20 per cent decline,which would reduce the value of your 5,000 equity holding to4,000. In these circ u m s t a n c e s ,you might well be willing to paya round 5 per cent of the value of your UK portfolio to insureagainst such a decline.

Buying a short turbo couldp rovide exactly that sort of insurance policy. At the time of writing, there are three turboshorts on the FTSE 100. Theseare the T103 with a strike priceof 5500, the T104 with a strikeprice of 5600 and the T105 witha strike price of 5700 (see table).

At the beginning of October,the underlying index the FTSE100 was trading at 4989. Youdecide to buy the safest of thethree turbo shorts the one with


A mores o p h i s t i c a t e dapproach isto used e r i va t i v e

products tohedge yourholdings ofshares andother ass e t s

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the knock-out level that is far-thest away from the curre n tprice of the index. The T105wont get knocked out unless theFTSE rises by more than 700points or 14 per cent.

Youve decided to pay 250 or5 per cent of the value of your UKequity holding for this turbo asinsurance. The cost per turbo is84.9p. Your 250 insurance fundbuys you 239 long turbos, less anotional 10 trading cost. Overthe next three months, the FTSE100 moves sharply downwards asyou expected, and hits 4500 bythe middle of December a fall of 489 points. These turbos wouldi n c rease in value to 1.36, a 60 percent gain from a 10 per cent fall inthe underlying index.

Turbos can also be used to hedgeagainst losses on particular equitypositions in a portfolio. This time,l e t s assume you have a port f o l i owith 10,000 invested inVodafone. At the end of S e p t e m b e r, Vo d a f o n e s share priceis 121p and you have 8,210 share s .But you think that the share price

will fall and you want to buy somep rotection. In this case, you opt toswitch 10 per cent of your holdings 1,000 into a short turbo, leav-ing you with 9,000-worth of Vodafone share s .

By the end of October, thes h a res do, indeed, fall to 100p afall of just over 17 per cent. Thes h o rt turbo on this part i c u l a rs h a re would have originally costyou 29.8p. But, by the end of O c t o b e r, this turbo would bepriced at 50p, an increase of justunder 68 per cent or some four

times the decrease in the underly-ing shares. Thus your 1,000insurance policy 990 afterdealing costs would now bew o rth 1,670, making you ap rofit of 670. By contrast, your

remaining 9,000 of Vo d a f o n es h a res would now be wort h7,416. So, your overall loss thed rop in the value of your re m a i n-ing shares plus the profit on your

turbo is only 900 on 10,000,leaving you with positions wort h9,086. Had you hung onto the10,000 shares and not bothere dwith the turbo, your paper posi-tion would be worth just 8,264.

Like any options-based hedgings t r a t e g y, using turbos re q u i res youto think very carefully about thelevel of risk that you are comfort-able with in a portfolio. Forexample, how much are you will-ing to invest in hedging yourunderlying holdings? You alsohave to consider the timescales

involved. Three months maysound like a long time, but youmight be wrong about how longthe market takes to go the way youexpect, even if you are right aboutits direction. The FTSE might dro p


10 per cent but it might not hap-pen until one day after the expiryof your turbo making your hedgew o rthless. Are you, there f o re, will-ing to keep hedging your port f o l i o

by rolling over your position withnew turbos, incurring the coststhat involves?

You should also scrutinise theknock-out level. Volatility in themarket could see the FTSE spikeabove 5500, possibly even to5700 over a one-week period,knocking out your turbo. Afterthat, though, the FTSE could stillfinish down at 4500 in thre emonths time as you expected, butyouve made no money at all.

It is also important to check thegearing on the turbo. If you are

seeking potentially super- s i z e dre t u rns, look for the maximumpossible gearing. If you want tomake smaller overall re t u rns withm o re safety, look for lower gearingand more distant knock-outs.

CURRENT TURBO SHORTS COMPA R E D

EPIC CALL OR PUT STRIKE PA R I TY E X P I RY UNDERLYING KNOCK OUT BID AS K SPOT PRICE ON UNDERLYING T

T 1 0 3 . L P 5 , 5 0 0 1 , 0 0 0 1 9 / 1 2 / 0 8 . F TS E 5 , 5 0 0 0 . 6 5 4 0 . 6 5 7 4 , 9 8 9 . 8 0 5 8T 1 0 4 . L P 5 , 6 0 0 1 , 0 0 0 1 9 / 1 2 / 0 8 . F TS E 5 , 6 0 0 0 . 7 5 1 0 . 7 5 4 4 , 9 8 9 . 8 0 5 8T 1 0 5 . L P 5 , 7 0 0 1 , 0 0 0 1 9 / 1 2 / 0 8 . F TS E 5 , 7 0 0 0 . 8 4 9 0 . 8 5 2 4 , 9 8 9 . 8 0 5 8

SPECIAL REPORT 9

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p rofit much more convincingly.We show in another article how

you can use stock and index tur-bos to protect your assets seepages 8-9. But how about usingindex turbos alongside your exist-ing holdings in order to addupside potential, rather than tolimit downside potential? Letssay you want to take a bullishposition on the direction of themarket, while maintaining a coredefensive stance.

H e re s how this particular strat-egy might work. Following asizeable drop, you think that themarket is due for a big re b o u n d .Rather than throw caution to thewind entire l y, however, you couldkeep a large part of your totalp o rt f o l i o s value in safe assets,such as government bonds ordefensive utility stocks. At thesame time, you also take a smallspeculative position on the FTSE100 going up sharply in value,committing, say, between 2 percent and 4 per cent of your over-all capital.

Now lets say that you have a

p o rtfolio worth 100,000 andthat you decide to invest 2 percent (2,000) in a FTSE 100index turbo with five times gear-ing. If the FTSE 100 index thenrises by 5 per cent in a single day perfectly possible in the volatilemarkets of today your turboindex could rise by 50 per cent invalue, leaving your positionw o rth 3,000, and generating ap rofit of 1,000. In terms of youroverall portfolio, youd haveadded 1 per cent to your overallre t u rns. That may not sound

much, but, given that long-termbuy-and-hold investing typicallygenerates re t u rns of 9 per cent ay e a r, 1 per cent in a day is not to

1 2 SPECIAL REPORT

Turbos can be used to produce powe rful returns that complement the perf o r m a n c eof your mainstream shares and bonds. David St evenson and Dominic Picardas h ow how you can make this approach work for yo u

S u p e r-c h a rgedreturns with turbosW HETHER YOUth i n k the marketsa re heading up ordown, turbos off e ra great way to earn super- c h a rg e d

re t u rns. This is because they are ag e a red product their pricesexperience exaggerated moveswhen the price of the assets

t h e y re linked to changes. So, if an index moves up or down by 1per cent, a turbo based on thatindex price can move up or down20 per cent.

I t s easy to see how this featurecould be useful. The ability tomake massive re t u rns off smallprice moves could seriously

i n c rease your wealth, if donep ro p e r l y. Say youve a stro n gbullish view on a particular equi-ty or index. Simply buying thes h a res or an index-tracker will

p robably only earn you pedestri-an re t u rns over a thre e - m o n t hperiod or less. But with turbos,you can turn your best ideas into


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be sniffed at. Of course, thepotential downside could beequally substantial. If the mar-ket moves in the opposited i rection to which you expect-ed, you could end up losing the2,000 you paid for your turbo.H o w e v e r, you can never loseany more than that initial out-l a y, unlike with many otherderivatives where youre on thehook for potentially enorm o u slosses. Even if that happens inthis example, though, youvestill got the remaining 98,000of your portfolio in safe assets,so your overall drawdown riskis very low.

It is also worth re m e m b e r i n gthat youre not doomed to loseyour entire turbo investment if things dont go as planned. Priorto the turbos expiry, there salways the possibility of sellingyour position at a loss. For exam-ple, you have a short turbo on theFTSE 100 with a knock-out barr i-er at 4500. The market risessharply to within 200 points of this barr i e r. You revise your pre v i-

ously bearish view and decide toget out now. You will not get backall of what you paid, but some-thing is better than nothing.Knowing when to admit yourew rong is an essential skill if youreto become a successful trader.

Its previous strategy of trying toexploit major rallies works outfor you a few times over a year,you could easily generate a re t u rnof 3 per cent or 4 per cent a yearover and above the re t u rn youe a rn on your core, defensiveassets. In essence, youre practis-

ing a classic absolute re t u rn s s t r a t e g y, as practised by hedge-fund investors every w h e re. Tomake this strategy work, youve


Turbos canalso be usedto makemoney frompricemovementsin individual

s h a r e s

SPECIAL REPORT 1 3

got to be very smart or lucky when it comes to timing. Movingin quickly, riding the best of themove and getting out sharpish isc rucial. The danger of such astrategy is that you get caughtholding geared long or short posi-tions for too much time in ap ronounced bear or bull market.

At the time of writing, one fair-ly significant obstacle topursuing this kind of strategy isthat there are no long index tur-bos available. Market volatilityand negative sentiment hasreached such extreme levels thatknock-out barriers on all pre v i-ously existing products havebeen reached. However, this islikely to prove only a temporarysituation. As volatility subsides,SG should be able to issue a fre s hbatch of turbos.

Turbos can also be used tomake money from price move-ments in individual shares. Letslook at a simple example of this.Assume that you accept thedefensive logic of buying intobig pharmaceutical shares as a

remedy to a long-term bear mar-ket. Established drug companiessuch as GlaxoSmithKline a n dAstraZeneca enjoy more stablesales and profits growth thanf i rms in many other industries,because medicines are notsomething that people can dowithout, even in hard econom-ic times.

Based on this view, you decidethat, over the nextt h ree months, GlaxoSmithKlines(GSK) shares a re likely to enjoy abounce. Rather than buying the

actual shares in order to pro f i tf rom this anticipated re c o v e ry,you invest in the long GSKturbo, called C733. At the

moment of purchase, GSKss h a re price was 1,188p, where a sthe turbo at that point cost108p. A month or so later, theGSK share price has moved upby 5 per cent to 1,250p a share .In response to that gain in theunderlying asset, the long GSKturbo shoots up from 108p to170p a 57 per cent increase inthe share price, or more than 11times the increase in actual GSKs h a res.

Be aware, however, that thishighly geared upside comeswith the usual risks attached. If the shares move in the wro n gd i rection, you could lose allyour money. The knock-outb a rrier for this turbo is set at1100, which means that, if thes h a res had moved down bym o re than 15 per cent, your ini-tial investment would have beenwiped out.

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WARRANTS HAV Ealways been a goodway for investorsto take low-risk

bullish or bearish positions on am e d i u m - t e rm view. At the sametime, contracts for diff e re n c e(CFDs) and spread betting off e rthe opportunity for investors togenerate large re t u rns from smallstakes. Turbos previously knownas listed CFDs or knock-outw a rrants now provide the best

of both worlds. T h e y re perfect for day trad-ing, says Alexandre Chess, headof UK listed products distributionat Socit Gnrales corporate &investment banking division,which is the main issuer of turbos.The high gearing works well overa short - t e rm horizon.

Turbos are a delta-one pro d-uct. This means that movementsin the price of the warrant movein parity with movements in theprice of the underlying asset.But because they are priced

much lower than the underlyingasset, small absolute pricemovements translate into higherp e rcentage changes.

Traders looking to get in andout of the market quickly needtools that allow them to magni-fy the relatively small percentagemovements of major indices orequities into bigger percentagere t u rns. The average dailychange of the FTSE 100 is lessthan 1 per cent, which makes ithard to make significant profits

without using gearing. Of course, in late September andearly October, average dailymoves became much bigger,thanks to some giant one-dayswings of more than 8 per cent.

Turbos have low sensitivity tovolatility moves. Again, this isgood news for day traders, as itmeans you dont have to paymore for turbos based on thevolatility of the market, in directcontrast to traded options,

which get more expensive thehigher the volatility on theunderlying asset becomes.

But why not use spread bettingto capitalise on small dailymovements? After all, a 1 percent move in the FTSE 100 isequal to 50 points and, at 100a point, that could rack up ahefty, tax-free profit in a veryshort timeframe. And a 100-a-point CFD against BritishAirways on 6 October wouldhave raked in as much as 2,000as the shares slumped on fund-

ing worries.The answer is that increasedvolatility also increases the riskof a trade going against you, andagain turbos offer traders signif-icant risk advantages comparedwith spread betting or unlistedCFDs. Trading with CFDs ors p read bets is essentially anopen-ended trade that can leadto almost unlimited losses.Those profits could easilybecome losses if, as has been thecase in recent weeks, unexpected

news sends the market sharplyin the opposite direction.

Turbos offer a degree of pro-tection not available elsewhere.True, youll have to forego someof the leverage, but thats a smallprice to pay for the peace of mind turbos give you. If themarket moves against you, themost you can ever lose on aturbo is your original outlay.Because turbos have an in-builtstop-loss called the knock-out

barrier investors will neverreceive the dreaded margin call,when the broker calls updemanding more money in orderto keep your position open.Of course, you can buy guaran-teed stop-losses with spread betsand standard CFDs, but this isan expensive optional extra.

Since turbos are listed on theLondon Stock Exchange, they arealso very easy to trade. Theyrea very straightforw a rd pro d u c t , says Mr Chess, They benefitf rom excellent liquidity and a

tight bid-offer spread. For daytraders, this means the ability tomove in and out of positions veryq u i c k l y. And almost all leadingb rokers offer the ability to tradein turbos.

Turbos are also cheap to trade. Aflat fee of around 10 to 25 istypically payable on a margin pay-ment of 10,000, and there s nominimum contract size whichmeans day traders can workt h rough a number of bite-sizedtrades. The tight spread wont eat

1 4 SPECIAL REPORT

The gearing on turbos make them great for transforming a few hours pricem o vement into big profits, but without the extreme risk of most other dayt rading, says John Hughman


The turbo route tod ay -t rading profits

Since turbosare listed onthe LondonStockExchange,they are also

very easy totrade.Theyre avery straight-forwardproduct,

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SPECIAL REPORT 1 5

up trading gains on small moves,e i t h e r. Two-point spreads is aboutas good as youll get anywhereand, unlike spread bets, thisremains steady throughout the lifeof the contract.

As youd expect, turbos are avail-able on a fairly wide range of leading equities and indices. Asmany day traders now rely ontechnical analysis exploitingt rends and reversals on the charts to inform their decisions, tradingwith turbos allows them to followexactly the same tried-and-testeda p p roach as they would whentrading with any other instrument.

L e t s take a look at two ideas forday-trading with turbos, bothusing technical analysis. Each of the approaches offers a diff e re n tlevel of risk, and there f o re shouldsuit most day-trading approaches.

HIGH-RISK TRADEBuy a long turbo with a price thatsclose to its knock-out barr i e r. Thekey diff e rentiating feature of tur-bos is their knock out feature e s s e n t i a l l y, an in-built stop-loss.

And while day-traders will need tot read carefully to ensure their posi-tions are n t knocked out veryquickly in turbulent markets, itsalso a feature that can count intheir favour.

The closer turbos fall toward stheir barrier level, the lower theprice of the turbo and with thedelta one characteristics thehigher the gearing they off e r. Agood example would be the T115,which has a knock-out barr i e r o f 4500, only marginally below theprice at the time of writing of

4640. A look at historic chart ssuggests that there may be a frag-ile level of support just above theknock-out level, at 4550.

A trader may decide that, hav-ing bounced off this level, themarket may continue rising. Het h e re f o re buys the turbo at 20.2p.A 1 per cent gain on the FTSEwould equate to a 4.6p gain onthe turbo a whopping 23 percent gain on the price paid mak-ing it an advantageous trade forthose looking to risk very small

amounts of initial outlay.In fact, in the five minutes I

took writing out this example,news of the US Federal Reserv e sdecision to buy up commerc i a lpaper sent the FTSE shootingu p w a rds, and the value of thiscontract increased to 30.7p, giv-ing a 53 per cent re t u rn .

H o w e v e r, the risk is that anothercalamitous day in the marketscould wipe out this position quick-l y. T115 turbo fell to within 15points of the knock-out price on7 October a close shave indeed.

MEDIUM-RISK TRADESA slightly less risky trade would bethe T114, priced at 38.5p with astrike of 4300. The lower risk andlower gearing means a 1 per centu p w a rd movement would onlytranslate into a 12 per cent gain still not bad for a days work andwith little chance of being knockedout altogether.

LOWER-RISK TRADESPlace a limit order to buy a shortturbo in a falling market.

Traders who think that marketswill fall through a level of sup-port rather than bounce off it can take out an option to buy aput turbo once the marketsbreak below a specified level.This is slightly less risky thantrying to predict a bounce and,in fact, traders can set their ownlevel of risk by deciding howmuch daylight they want to seebetween the purchase price andthe strike/knockout level. Again,the greater the distance betweenthe purchase price and the

knockout, the lower the gearingthe trade offers.L e t s take a look at two curre n t

s h o rt turbos to illustrate this. TheT103 with a knock-out barr i e rof 5500 can be bought for 81.3p(17 per cent above the FTSE 100sc u rrent level) and is unlikely to beknocked out in the short term .But that reduced risk comes at acost a one percentage pointmove in the FTSE only re p re s e n t sa 6 per cent move in the turbo.

A slightly less risk-averse investor


might even choose the T105 shortturbo, which has a knock-out bar-rier at 5700, further away from thelevel of the FTSE today. The priceof the turbo is corre s p o n d i n g l yh i g h e r, which means that everyd o w n w a rd move in the FTSErelates to a 5 per cent re t u rn.

Both trades would have beenout-of-the-money on the Fedannouncement, but neither wouldhave been knocked out. But if weassume that this marks the start of a short countert rend rally, it couldp resent an opportunity at whatlooks like resistance levels at 5300,5450 and 5650. If the market failsto breach these levels, there couldbe subsequent sharp falls which,given the proximity to the knock-out barr i e r, could be exploitedwith much higher gearing.

O b v i o u s l y, trying to predict thepeak and buying on the way upi n c reases the risk of beingknocked out, so it makes moresense to trade on the downwardmomentum if the market re v e r s-es. This trade could be automatedusing a conditional limit ord e r,

which would buy at a set level onthe way down after hitting ahigher target.

News of theUS Fe d e r a lRe s e rv e sdecision tobuy upc o m m e r c i a lpaper sent

the FTS Es h o o t i n gupwards, andthe value ofthis contractincreased to30.7p, givinga 53 per centr e t u r n

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1 6 SPECIAL REPORT

The best way to understand what turbos can do for you is to see how a success f u lt rader uses them. Our widely followed columnist, Simon Th o m p s o n , reveals how heuses these instruments to generate marke t- b e ating returns.

Trade turbos like a pro

THE MOST IMPOR-t a n t lesson I havelearned in the past 20years is how to play the

percentages. Your view of themarket may be right, but unlessyouve got the right instrumentto exploit that view, you wontmake money. This is especiallyt rue when you use leveragedproducts such as contracts fordifference (CFDs), turbos andc o v e red warrants, as these

i n s t ruments exaggerate yourgains and losses.Before entering any trade, I

make sure that I am givingmyself enough time for otherinvestors to come around to myway of thinking. Therefore, it isessential that the product I use totrade has at least the same timehorizon as I need for my view onthe markets to pan out.Secondly, I never want to getstopped out on a trade, so Ialways choose a product where Iwill be around to fight another

day even if the position is goingagainst me in the short term.This is especially important involatile markets.

For instance, consider a traderwho was short of the FTSE 100on Thursday 18 Septemberwhen the market closed at4880. One day later, the indexre c o rded its biggest daily gaine v e r, closing a massive 431points higher at 5311 and hit-ting an intra-day high of 5351,driven by news of a ban on the

s h o rt-selling of financial share sand a US government bailoutplan for the beleaguered bank-ing sector.

With some spread-betting firm sand CFD providers, a 10 per centrise in the index from Thursdaysclose to Fridays intra-day highwould have been enough to wipeout the margin the trader had putup on the short position andwould have meant the shorttrade would have been automat-

ically closed out. But just 12 dayslater the FTSE 100 had fallenback to 4671, so the traderwould not have profited eventhough he was ultimately right inhis bearish view. This is exactlywhy I am so keen on using cov-e red warrants and turbos totrade the indices.

MY BEST TRADE OF 2008:F TSE 250 SHORT- L I ST E DTURBO TRADEMy best trade this year was as h o rt trade on the mid-

cap index ( I N V E STO R S C H R O N I C L E ,Bad tidings, 7 January 2008)t h rough a FTSE 250 short - l i s t e dturbo, C433. I was very bearishon the outlook for UK equities,given the impending economicslowdown in this country andthe fallout from the intern a t i o n-al financial crisis. To capitaliseon my view, I decided to shortthe FTSE 250, an index stuff e dfull of medium-sized companiesthat are focused on economical-ly sensitive and consumer- f a c i n g

indus tries, such as pro p e rt y,housebuilding, f inancials, banksand stockbro k i n g .

I chose the short-listed turbo,C433, because it had a k n o c k -out barr i e r of 12550 and had sixmonths to expiry on 11 July2008. There f o re, I was givingmyself ample time for thed i re economic and corporatenews to emerge and the savagede-rating of FTSE 250 sharesto take effect. More o v e r, with

the FTSE 250 trading at 10200in January I felt there was nochance of being stopped outof this instrument if themarket moved against me inthe near term .

R e m e m b e r, the FTSE 250 hads o a red to an all-time high of 12282 in May 2007 on the backof a mergers-and-acquisitionsf re n z y. However, the credit cru n c hled to a dramatic fall in takeovera c t i v i t y, which pulled the rug fro munder share-price valuationsamong mid-cap firms. As I saw it,

t h e re was no way the index wasgoing to revisit those re c o rd highsand hence no way I would ever getstopped out of my short turbop o s i t i o n .

In addition, the turbo inquestion off e red good valueand traded on a relatively tighttwo-point bid offer spread. Ipaid 2,584p per turbo, whichequated to 2584 points on theFTSE 250, in early January.H o w e v e r, as the turbo had2350 points of intrinsic value

Beforeentering anytrade, I makesure that I amgiving myselfenough time

for otherinvestors tocome aroundto my way oft h i n k i n g


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SPONSORS PROFILE

Awarded Equity Derivatives House of the Year four timesby IFR, Risk Magazine, the Banker and Euromoney, SG CIBhas reinforced its position as a: Worldwide leader in Equity Derivatives Worldwide leader in Warrants Key player on the European ETFs market

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