How to use certificates
Certificates are traded on markets in the same way as stocks and bonds.
It is then important to understand how each certificate works and, subsequently, choose the one which fits at best the risk-return profile.
The investment process could be structured as follows:
- Trade idea on a specific asset class: equities, bonds, commodities, currencies, short-term interest rates.
- Selection of an underlying asset according to existing market expectations, trying to identify the expected return. For example, if the chosen asset class is equities, one will need to decide in which stocks or indices invest.
- Once the investor has chosen to purchase equities, for example European stocks included in the Eurostoxx 50 index, he has to set an expected return on his investment. Based on the results of his analysis and predictions, he has to balance his expectations on the underlying performance and his risk tolerance, identifying an appropriate risk-return combination. An investor may be strongly bullish or bearish on an asset, which may let him purchase leveraged products. At the same time, he may have a very low risk tolerance: in this case, the best option for the investor is to buy a certificate that offers full or partial capital protection against losses.
- Once the asset to invest in and the appropriate risk-return combination are identified, the investor must find the best available financial product which fits his strategy. The choice depends also on the characterizing elements of each certificate, like maturity, strike price, barriers, coupons, early expiration, etc. All these elements are relevant if the certificate is purchased when issued, and their importance increases significantly if the certificate was already traded in the market when bought: in this case, the certificate’s price movements are also related to the underlying asset’s price movements, volatility, interest rates, and time.
- Where the chosen asset classes and/or underlying assets are more than one, this entire process would need to be repeated more than once. The investor can create portfolios of certificates, combining the various available typologies, always diligently taking into account market expectations and his or her risk tolerance.