Derivatives Basics

What is a Derivative?

A derivative is a financial product whose value is derived from an underlying asset. You don't own the asset itself — you own a contract that tracks its price.

The asset that a derivative is based on is called "the underlying". Throughout this article, when we say "the underlying", we mean the actual asset (stock, index, commodity, etc.) that the derivative tracks.

Underlying assets can be:

• Stocks (Apple, Tesla, SAP...)
• Indices (DAX, S&P 500, NASDAQ...)
• Commodities (Gold, Oil, Silver...)
• Currencies (EUR/USD, GBP/USD...)

Why use derivatives instead of buying the asset directly? Two reasons: leverage and flexibility (you can profit from falling prices too).

The three main types of leveraged derivatives are:

• Knock-Out Products (Turbos) — leveraged products with a barrier that terminates the product instantly if touched
• Warrants — the right to buy or sell at a set price before expiration, with no knock-out barrier
• Factor Certificates — constant daily leverage (e.g., 3x, 5x) that resets every trading day

Each type is covered in detail in Leveraged Derivatives Explained. This article focuses on the core concepts that apply across all of them.

Long vs Short

Before diving into the details, you need to understand the two directions you can take:

Note on terminology: Knock-out products and factor certificates use the terms Long and Short. Warrants use Call (bullish, similar to Long) and Put (bearish, similar to Short). The concept is the same — the naming just differs by product type.

Core Concepts

Strike Price

The reference price set when the derivative is created. It determines the product's intrinsic value and is the level the underlying must move beyond for the derivative to have intrinsic value. (A warrant can still have time value even if the underlying hasn't reached the strike yet.)

Example: A Long derivative with a strike of 100 EUR on a stock trading at 110 EUR has an intrinsic value of 10 EUR (110 - 100).

• For a Long derivative: You profit when the underlying's market price is above the strike
• For a Short derivative: You profit when the underlying's market price is below the strike

The further the underlying moves away from the strike in your favor, the more the derivative is worth.

Price and Premium

The price you pay to buy a derivative. Depending on the product type, this price is made up of different components:

1. Intrinsic value — the real, calculable value (underlying price minus strike for a Long product)
2. Time value — extra cost for the time remaining, reflecting the chance that the underlying's price could still move in your favor before expiry

Warrants typically have significant time value on top of their intrinsic value — this is often called the premium. Knock-out products, on the other hand, trade close to their intrinsic value with very little time value.

Example: A warrant has a strike of 100 EUR, the underlying trades at 108 EUR, and the warrant costs 12 EUR.

• Intrinsic value: 8 EUR (108 - 100)
• Time value: 4 EUR (12 - 8)

The time value decays as the product approaches maturity. This is called theta decay — the derivative loses value just by time passing, even if the underlying doesn't move.

Example: You buy a warrant for 12 EUR (8 EUR intrinsic + 4 EUR time value). A week later the underlying hasn't moved at all — but your warrant is now worth 11 EUR. You lost 1 EUR purely from time decay.

Maturity (Expiry)

The date when the derivative expires. After this date, the product ceases to exist.

• Fixed maturity: The product has a set expiration date (days, weeks, months away)
• Open-end: No expiration — the product lives indefinitely (but has ongoing financing costs)

At maturity, only the intrinsic value remains. All time value is gone.

Leverage

Derivatives give you amplified exposure to price movements without needing the full capital to buy the underlying.

Example: A stock trades at 100 EUR. You could buy the stock directly for 100 EUR — or buy a Long knock-out derivative with a strike of 95 EUR for just 5 EUR.

Why does this derivative cost 5 EUR? Because its intrinsic value is 5 EUR (current price 100 - strike 95). Knock-out products trade near intrinsic value, so that's roughly what you pay. (A warrant with the same strike would cost more due to the added time value.)

Now compare what happens with a 5% move:

• Stock rises 5% (to 105 EUR): The derivative's intrinsic value becomes 10 EUR (105 - 95). You paid 5 EUR → 100% gain. The stock only moved 5%, but your derivative doubled.
• Stock falls 5% (to 95 EUR): The derivative's intrinsic value becomes 0 EUR (95 - 95). You paid 5 EUR → 100% loss. The stock only dropped 5%, but your entire investment is gone. In this case, the price has hit the knock-out barrier (strike = 95), so the product is also immediately terminated.

Leverage = Underlying price / Derivative's market price (what you actually pay). In this case: 100 / 5 = 20x leverage. If you had paid more (e.g., 7 EUR for a warrant with time value), the leverage would be lower: 100 / 7 = ~14x.

Higher leverage means bigger gains AND bigger losses. It cuts both ways.

Knock-Out (Barrier)

Some derivatives have a barrier level. If the underlying asset's price touches this level, the product immediately expires. There is no way to recover — the product is terminated regardless of what happens after.

Example: You buy a Long knock-out with a barrier at 95 EUR. The stock drops to 95 EUR. Your product is instantly terminated, even if the stock bounces back to 110 EUR a minute later.

There are two variants of where the barrier sits:

1. Barrier = Strike (Classic Turbos, Open-End Turbos): The knock-out barrier and the strike price are the same. When hit, the intrinsic value is exactly zero → total loss.

2. Barrier separate from strike (Mini Futures): In Mini Futures, the barrier is called the "Stop-Loss Level" and it sits between the current price and the strike (financing level):

• Long Mini Future: Stop-loss is above the financing level
• Short Mini Future: Stop-loss is below the financing level

This creates a safety buffer. When the stop-loss is hit, there's still intrinsic value remaining (because the strike hasn't been reached yet), so you may receive a residual payment. You still lose most of your investment, but not necessarily all of it.

Exiting a Position

You don't have to hold a derivative until maturity or knock-out. You can sell it back at any time during trading hours. The issuer (acting as market maker) will buy it back at the current bid price.

This means you can:

• Take profits early if the underlying moved in your favor
• Cut losses before a knock-out barrier is reached
• Exit whenever you change your mind about the trade

The price you receive when selling is the current market price of the derivative, which reflects the intrinsic value plus any remaining time value.

Financing Costs

Leverage isn't free. When you buy a leveraged derivative, the issuer essentially lends you money to amplify your exposure. This financing has a cost:

• Fixed maturity products: Financing costs for the entire duration are baked into the premium upfront — this is why the price is higher compared to open-end products
• Open-end products: Since there's no expiry to calculate against, the issuer charges financing costs daily by adjusting the strike price instead — lower price, but the strike moves against you every day

How daily adjustment works for open-end products:

• Each day, the strike is adjusted slightly — increased for Long, decreased for Short
• The daily cost = (Reference rate + Issuer spread) / Trading days per year
• Reference rates: EURIBOR (Europe), SOFR (US)
• Issuer spread: typically 2-4% annually

What this means: If you hold an open-end Long derivative and the underlying doesn't move, you're losing money every day because the strike keeps creeping closer to the current price. Even in a slowly rising market, financing costs can eat into your gains if the move is too small.

This is not the same as theta decay. The effect feels similar (you lose money while nothing happens), but the cause is different:

• Theta decay (warrants): You lose time value — the "chance premium" shrinks as expiry approaches
• Financing cost (open-end knock-outs, Mini Futures): The issuer charges you for the leverage loan by moving the strike — your intrinsic value shrinks

Knock-out products trade near intrinsic value with almost no time value, so theta isn't the issue. The daily strike adjustment is purely a financing charge.

Key Takeaways

• A derivative's value comes from an underlying asset, amplified by leverage
• Long = betting on price rising, Short = betting on price falling
• Strike price + price paid determines your breakeven — you need the underlying to cover both before you profit
• Time value decays over time — especially relevant for warrants
• Knock-out barriers can terminate your product instantly
• Leverage amplifies both gains and losses equally
• Financing costs eat into open-end positions daily — sideways markets are your enemy
• You can exit any position early by selling back to the issuer

Not financial advice. Always do your own research.

Last updated: February 2026