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Daily Leverage Certificates (DLCs)
Why Us?
Why Trade DLCs?
What are DLCs?
Daily Leverage Certificates (DLCs) are a form of structured financial instrument issued by banks and traded on the securities market. DLCs offer investors fixed leverage of 3 to 7 times the daily performance of an underlying index, be it a rising or falling market. The basic principle is simple – if the underlying index moves by 1% from its closing price of the previous trading day, the value of the 3x DLC will move by 3%.
SGX is Asia’s first venue to offer trading in DLCs, allowing investors to gain fixed leveraged exposure to developed Asian 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.
How does a DLC works?
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 level, there is a long and short DLC available. A bullish investor who thinks that the underlying index is set to rise over the trading day can select, for example, a 3x Long DLC, which will rise in value by 3% for each 1% rise in the underlying index (before costs & fees). A bearish investor who expects the underlying index to fall can instead select, for example, the 3x Short DLC, which will rise in value by 3% for every 1% fall in the underlying index (before costs & fees).
Compounding Effect
If the investor’s trading horizon is over a few days, it is important to note that the performance of the DLC may vary from the leverage factor of the DLC. This is because the performance of the underlying index and the DLC is reset at the end of each trading day. When markets open the next day, the performance of the underlying index and the DLC will be measured from the closing levels recorded on the previous trading day. This means that any subsequent performance of the DLC is calculated based on the performance achieved the day before. The same process is repeated on each trading day. Over the period of more than one day, the profits or losses are thus compounded.
Airbag Mechanism
An airbag mechanism is built into the DLC to slow the rate of loss in the value of the DLC in extreme market conditions. 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 for a 5x DLC and a 20% movement for a 3x DLC (based on the closing price of the underlying index in the previous trading day). The airbag mechanism will only be triggered upon movements of the underlying index that go against the direction of the product. For example, if the underlying index falls by 20%, (a) the airbag mechanism for a 3x Long DLC will be triggered as the value of the DLC will go down with the fall in the underlying index; but (b) the airbag mechanism for a 3x Short DLC will not be triggered because with the fall in the underlying index, this DLC will increase in value by 60% (3 x 20%).
Learn more about DLCs here
Are DLCs suitable for you?
Daily Leverage Certificates (DLCs) are for investors who are willing to accept the risk of substantial losses of 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. All investors need to be Specified Investment Products (SIP) qualified to invest in DLCs. DLCs seek to achieve short-term investment results that correspond to the daily magnified performance of the underlying benchmarks.
Know Your Risks
Investors risk losing part or all your investment if the issuer defaults or is not credit worthy. It will also be harder to seek for legal recourse when issuer is a foreign entity as the process will follow foreign legislation.
If the underlying asset falls to levels such that the cash settlement amount is calculated to be less than or equal to zero, the investor may lose the entire investment.
Secondary market may have lower liquidity, which may result in difficulty to Buy/Sell at times.
There will be exchange rate risks when the DLC is in Singapore dollars, but the underlying asset is traded or denominated in foreign currency.
Losses will be multiplied depending on the leverage, resulting in losses more than if investors had invested directly in the underlying instrument.
When DLCs are held for more than a day, its performance could be more or less than the leverage factor that is embedded within the certificate. This is due to a compounding effect, where the performance of the DLC each day is locked in, and any subsequent returns are based on what was achieved the previous day. This may cause losses to be amplified in volatile markets, resulting in investors sustaining substantial losses.
Learn more about DLCs here
Other features of DLCs
Limited lifespan – DLCs have a limited life with a maximum tenure of 3 years.
Delisting – A DLC will be delisted upon maturity, or upon the issuer’s request because the DLC has lost all its value due to extreme market movements.
Adjustments for corporate actions on underlying securities – If the underlying reference instrument of a DLC is a share of a corporation, the DLC issuer may make adjustments to the DLC if the issuer of the underlying shares undertakes a corporate action (such as a bonus issue).
If so, the DLC issuer will determine whether the corporate action has a dilutive or concentrative effect on the value of the underlying shares, It will then adjust the leveraged return of the underlying shares to preserve the economic equivalent value of the DLC and determine the effective date of that adjustment.
For more information on DLCs, please visit SGX Website and Issuer’s Website, or contact your trading representatives.
