Table of Contents
- Essence of ELW and Prerequisites for Approach
- Structure of ELW and Working Principle of Leverage
- Sensitivity Indicators Determine Profits and Losses
- Cautions in Interpreting Theoretical Price, Deviation Rate, and Parity
- ELW Investment Methods and Practical Operation Principles
- Conclusion: Approaches without Rules are the Most Dangerous with ELW
- Frequently Asked Questions (FAQ)
Essence of ELW and Prerequisites for Approach
ELW is a type of securities that gives the right to buy or sell an underlying asset at a predetermined price for a specific period. This right is a derivative product listed and traded on the exchange.
Although it has a structure similar to options, it is differentiated by the fact that the issuer is a brokerage firm. The liquidity provider (LP) always offers quotes, so the perceived profits and losses may differ from traditional option theory. This difference can be a significant consideration for investors.
The premium paid at the time of buying an ELW becomes the maximum limit of the loss. If the right becomes invalid at expiration, the price approaches zero. Therefore, it is essential to consider that "even if the direction is correct, losses can occur if the timing is wrong" when investing in ELW.
Structure of ELW and Working Principle of Leverage
ELW is classified as a leverage product because it can produce similar directional investment effects with a significantly smaller amount compared to physical assets.
The basic structure of ELW is divided into two types. First, call ELW increases in value when the price of the underlying asset rises, and second, put ELW increases in value when the price of the underlying asset falls.
When the price of the physical asset changes by 1%, the value of that asset typically changes by about 1% as well. However, ELW has a small price unit and a simple structure, so even minor fluctuations in the underlying asset can have a significant impact on the ELW price. This phenomenon is made possible by a metric known as delta (Δ).
Delta indicates how much the ELW price reacts when the underlying asset changes by one unit. The delta of a call option ranges from 0 to 1, while the delta for a put option ranges from -1 to 0, with larger absolute values tracking the underlying asset more directly.
However, leverage not only increases profits but also amplifies losses, and it is essential to be aware that the time factor works structurally disadvantageously in the case of ELW.
Sensitivity Indicators Determine Profits and Losses
The profits and losses of ELW cannot be explained solely by direction, as various sensitivity indicators operate in a complex manner.
The main sensitivity indicators are as follows.
Theta (Θ) indicates how much value decreases over time.
Vega (ν) shows the price sensitivity to changes in implied volatility (IV).
Gamma (Γ) represents the rate of change of delta, helping to understand the changes in volatility.
Finally, Rho (ρ) measures sensitivity when interest rates change.
These indicators together determine the critical elements of ELW profits and losses.
In practice, the most pronounced elements are theta and vega. As expiration approaches, the absolute value of theta increases sharply, and even if the underlying asset moves in the desired direction, the diminishing time value can limit profits or lead to losses.
If the volatility index (IV) fluctuates sharply before and after events, there can be cases where profits and losses worsen due to the reduction of volatility, even if the direction is correct.
Additionally, in regions with high gamma, profit opportunities increase, but at the same time, volatility risk also rises. Understanding and responding to these factors is crucial.
Cautions in Interpreting Theoretical Price, Deviation Rate, and Parity
In actual ELW trading, indicators to judge price distortion are as critical as sensitivity indicators.
A key indicator is the theoretical price, which is an approximation of fair value derived from an option pricing model.
Deviation rate indicates how expensive or cheap the current price is compared to the theoretical price, making it an important metric.
Finally, parity is a measure that expresses the current price level as a percentage against intrinsic value. These indicators can be useful in ELW trading.
In the ELW market, deviation rates often widen due to liquidity, LP spreads, and hedging costs during rapid changes. Purchasing when the deviation rate is high significantly increases the likelihood of diminished expected returns from the outset.
The concept of parity can be helpful, but definitions may differ between HTS and MTS, so it is essential to check the basis of the numerator and denominator. Especially in OTM areas, the significance of parity diminishes, making it crucial to consider deviation rates, spreads, and remaining maturities together.
ELW Investment Methods and Practical Operation Principles
ELW investments are divided into directional trading and event/volatility trading, with establishing principles for directional trading being the most important for individual investors.
The steps to check during actual investment are as follows.
First, verify the volatility characteristics of the underlying asset and the schedule of events. Next, assess exposure intensity through delta and IV levels, and analyze deviation rates and spreads to determine whether price distortion exists. Finally, consider the remaining maturity to evaluate theta burden.
When approaching investment, it is better to divide purchases rather than invest all funds at once. Setting stop-loss criteria based not just on price, but on the conditions under which initial investment hypotheses are shaken is more rational.
When setting target profits, it is essential to consider not only whether the price of the underlying asset has been reached, but also the normalization of deviation rates and the spread's condition. Therefore, a phased liquidation strategy is necessary.
Conclusion: Approaches without Rules are the Most Dangerous with ELW
ELW allows for significant exposure with a small amount but always carries the risk of total loss.
Because of this, it is essential to maintain the proportion of ELW at an appropriate level within accounts, and meticulously manage to avoid excessive overlapping positions in the same direction.
Theoretical prices and deviation rates do not present answers but serve as warnings. Ultimately, the success of ELW depends on the alignment of four elements: outlook on the underlying asset, time management, volatility, and market microstructure (LP and liquidity).
Establishing a checklist to verify these elements and managing risks through rules that can be repeatedly applied is a practical way to ensure long-term survival in ELW investing.
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Frequently Asked Questions (FAQ)
Q. What is ELW and what features does it have?
ELW is an Equity Linked Warrant that gives the right to buy and sell the underlying asset at a predetermined price within a specific period.
ELW is classified as a derivative product and traded on the exchange. It provides the right to buy or sell the underlying asset at a predetermined price for a specific period, and it is issued by a brokerage firm. While it has similarities to traditional options, the continuous quotes from liquidity providers can yield different perceptions of profit and loss.
Q. Why is ELW classified as a leverage product and what is its basic structure?
It produces directional investment effects with a small amount and is divided into two structures: call and put.
ELW is a leverage product because it can yield investment effects based on the price fluctuations of the underlying asset with little capital. The basic structure consists of call ELW, which gains value when the underlying asset's price rises, and put ELW, which gains value when the underlying asset's price falls. This allows the investor to invest according to the price direction.
Q. What does delta (Δ) mean in ELW investment and how does it work?
Delta is a sensitivity indicator that indicates the change in ELW price for a one-unit change in the underlying asset.
Delta ranges from 0 to 1 for call ELW and from -1 to 0 for put ELW. The larger the absolute value, the more directly the ELW price tracks changes in the underlying asset, and minor changes in the underlying asset can greatly impact the ELW price. Thus, delta is a key metric for understanding investment exposure levels.
Q. What are the main sensitivity indicators in ELW investment?
Theta, vega, gamma, and rho are important sensitivity indicators affecting ELW profits and losses.
Theta indicates the value decrease over time, while vega shows price sensitivity to changes in implied volatility. Gamma indicates the rate of change of delta, and rho measures price sensitivity to interest rate changes. These indicators work together to determine ELW profits and losses.
Q. What role do theoretical price, deviation rate, and parity play in ELW investment?
Theoretical price denotes fair value, deviation rate indicates price discrepancies, and parity serves as an indicator of price level relative to intrinsic value.
The theoretical price is an approximation of fair value based on an option pricing model, while the deviation rate indicates the pricing difference between the current price and the theoretical price. Parity denotes the current price level against intrinsic value as a percentage. These indicators help in assessing potential price distortions for more rational ELW trading.
Q. What are the practical operation principles for ELW investment?
Phased buying, stop-loss based on investment assumptions, and phased liquidation upon achieving target profits are important.
It is advisable to use phased buying rather than investing the entire amount at once, and stop-loss criteria should be based on conditions that question initial investment assumptions rather than on price alone. When reaching target profits, it is necessary to implement a phased liquidation strategy that considers not only reaching the price of the underlying asset but also the status of deviation rates and spreads.
Q. How should the risk management of ELW investments be conducted?
Managing the proportion of ELW in accounts and limiting overlapping positions to reduce total loss risk is crucial.
While ELWs allow for significant exposure with a small amount, the risk of total loss necessitates maintaining a proportion of ELW at an appropriate level. Furthermore, it is essential to avoid excessive overlapping positions in the same direction to distribute risk, and utilizing a checklist that allows for repetitive review is favorable for adhering to investment rules and ensuring long-term survival.
