Warrants with Knock-Out: How they work

Changes in the implied volatility of the underlying asset only have a minimal effect on the value of a Warrant with Knock-Out. The pricing is thus transparent and easily comprehensible.

When the price of the underlying asset reaches, falls (Call) or rises above (Put) the Knock-Out level during the observation period, the product immediately expires worthless. The Knock-Out level is continuously monitored starting from the initial fixing date.

A Knock-Out event for a Call Warrant with Knock-Out occurs when the price of the respective underlying asset touches or falls below the current Knock-Out level at any point during the trading hours of the underlying asset on the reference exchange or determining entity (continuous observation). For a Put Warrant with Knock-Out, a Knock-Out event is triggered when the Knock-Out level is reached or if the underlying rises above.

Here, a distinction must be made between the trading hours of the product and those of the underlying asset. The products are listed and can be bought or sold during regular exchange trading hours. Different trading hours may apply depending on the underlying asset. It is important to note that, for example, currencies can be traded almost continuously, whereas the trading for products on currencies depends on the exchange trading hours. This means a Knock-Out event could occur without the investor being able to sell the product on the exchange. Therefore, investors should inform themselves about the trading hours of the underlying asset before purchasing such products.

The price of a stock is adjusted by the amount of the dividend on the ex-dividend date. Similarly, adjustments are made to a Warrant with Knock-Out.

For a Call product, on the ex-dividend date of a stock, the net dividend is subtracted from the Knock-Out level. The net dividend considers the tax factor of any dividend payment.

For a Put product, the adjustment considers the gross dividend. The exercise price is reduced by the gross dividend.

For Warrants with Knock-Out, it is possible that a premium is charged in addition to the intrinsic value. In products with a fixed term, the premium represents financing costs and a risk premium, while in products without a fixed term (Open-End), only the risk premium is considered in the premium.

The risk premium serves to hedge the so-called gap and liquidity risk. Gap risk describes the issuer's risk that the hedging transaction cannot be reversed at the Knock-Out level in the event of a Knock-Out event. Liquidity risk reflects the tradability of the underlying asset.

To answer this question, a distinction must be made between products with a fixed term and those without a fixed term (Open-End).

The Knock-Out barrier of Knock-Out Warrants with a fixed term is set at issuance and does not change.

For Knock-Out Warrants without a fixed term (Open-End), the Knock-Out barrier is adjusted at the end of each adjustment day. An adjustment day is considered to be any day from Monday to Friday after the initial fixing day. Daily adjustments are made to account for the issuer's financing costs.

In practice, an adjustment of the Knock-Out barrier for Call products means an increase in the Knock-Out barrier, and for Put products, it means a lowering of the Knock-Out barrier.

Future contracts have a fixed term. For a product without a fixed term, the underlying asset must be replaced to ensure the continuation of the product.

In the case of a Call Warrant with Knock-Out, the issuer sells the current contract and buys a longer-term contract. This process is also referred to as a "rolling" of futures.

A similar process occurs for a Put Warrant with Knock-Out. The short position of the previous contract is closed through a purchase, and the short position is re-established in the new, longer-term contract.