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Asset classes (II): The Wilder Ones
Estimated reading time: 12 minutes

Key takeaways:

  • 5 more complicated asset classes include: Crypto, Forex, Options, Daily Leverage Certificates (DLCs), and Contracts for Difference (CFDs)

  • The key risk factors for these asset classes include: Price volatility, variety (of products and trading strategies), as well as the additional layer of decision-making they add for investors

  • Certain asset classes such as Cryptocurrency have not been adopted and researched widely enough to have a full picture of their risk factors

  • For other assets such as CFDs, investors risk losing more than just their principle sum invested

  • All in all, when thinking of trading such asset classes, one needs to be
    PARTICULARLY CAUTIOUS

DISCLAIMER: The following content represents entirely my own perspectives and opinions  it does NOT constitute any form of product marketing or recommendation, nor does it represent any form of financial advice per se.  

High risk, high reward... But can you stomach it?

The world of asset classes is complex.  In my earlier Asset Classes article, I touched on 4 mainstream asset classes found in investment portfolios. 

 

But that really just scrapes the surface of what's available out there for investors. 

 

In this article, I will attempt to explain 5 other asset classes, to let you have an insight regarding their complexities.  

 

As a qualification, I am FAR from an expert on some of these asset classes, so I don't think I'll be able to shed light on ALL the intricacies and mechanics behind how they work.

The key message from this article is that, if you are interested in these asset classes, it is EVEN MORE CRUCIAL that you (a) know what you are getting into, and (b) know what you are doing when investing in them.

1.  Cryptocurrencies (Crypto)

Crypto is a new-age investment product that has recently caught the attention of investors and analysts alike, due to its sheer volatility and variety. 

 

Crypto essentially is a digital currency used for payments, which is far more difficult to counterfeit than physical currency. 

 

Using Crypto as a means of payment thus far reduces the likelihood of fraud occurring, as all transactions are recorded in a secure ledger

 

The word “crypto” hints at the kind of encryption used on the blockchain network (on which Crypto transactions occur).

 

Different Cryptos have different uses and adoption rates, and the total market capitalization of each Crypto can be vastly different from others.  Bitcoin and Ethereum are currently the Cryptos with the largest market capitalization. 

 

But, as mentioned in the previous paragraph, variety is certainly a thing in Crypto, and there have been nonsensical Cryptocurrencies created, such as Dogecoin and Shiba Inu coin

 

Needless to say, because these assets were not backed by any fundamentals, nor have practical usage OR widespread acceptance, the mania surrounding them died completely and quickly, with some of these coins experiencing 99% declines in price…

 

The fact that there was a mania in the first place, where the value of these coins had risen by hundreds of times at their peak, is heavily suggestive of the non-rationality behind this asset class.

At the same time, volatility is probably the scariest part of Crypto – I don't know about you, watching the fluctuation in the Crypto market's value on a daily basis is enough to send jitters down my spine, as an investor. 

 

Moreover, the Crypto industry has been rocked with high profile events, such as Luna's collapse, as well as FTX's bankruptcy in late 2022 (which took off tens of billions of dollars of value from the Crypto market within days).  


Thus, to summarise the various reasons why Crypto is so risky:

 

a.  The asset class is not backed by any concrete underlying entities, such as companies, whose numbers and track record you can verify

b.  As an extension to the above point, it is also very difficult to properly value Crypto

c.  The "hype" around Crypto entails higher levels of irrationality in Crypto trading

d.  Related to the 2 points above, the volatility of Crypto as an asset is extremely high

e.  Crypto simply has not been adopted and discussed widely enough to fully understand the potential risk factors behind it

2.  Foreign exchange (or Forex)

Forex trading involves the buying and selling of currency exchange rate pairs.  The price of each pair (e.g. USD/SGD) is the ratio of the value of the USD to SGD, or vice versa. 

 

For instance, for the USD/SGD pair, a trade value of $1.33 means that 1.33 SGD is required to buy 1 USD.  

 

Forex is generally high risk as well, which explains why it is traded in the short-run rather than invested in per se. 

 

Similar to Crypto, there are little proper "fundamentals" you can analyze which are related to this class of asset, though, to be fair, at least there is an entity backing it (the Central Banks of the respective countries). 

 

Forex is also highly susceptible to geopolitical events – this was obvious in the price movements of the Russian Ruble when Russia invaded Ukraine. 

 

Neither is Forex immune to domestic and international market conditions – e.g. the collapse of several Southeast Asian countries' currencies went hand in hand with the Asian Financial Crisis of 1997.


To trade Forex, you need to have a dedicated Forex trading app – they are NOT the same as your usual brokerage accounts/platforms.  IG, IBKR, Saxo, and CMC Markets are currently the most commonly used Forex trading apps/platforms.

3.  Options

Options add a layer of complexity to investments.  Options are tied to, but are NOT the same as, their underlying assets.  When one buys and sells options, one is buying and selling a right rather than the actual asset (e.g. a company's stock). 

There are 2 main types of Options: Call and Put

 

Call options grant us the right to buy a stock/asset at a stated price (known as the exercise price).  These are typically used for long positions (or when there are positive expectations about the price of a stock).

Put options are the opposite, granting the right to sell the stock at the stated exercise price, and are typically used when investors currently own the stock, but expect the stock’s price to FALL

 

In buying an option, you are NOT obligated to exercise it – that is, you are not forced to buy or sell the underlying stock when the options expire

 

Assuming you have correctly predicted the stock's price movement, you can profit from these stock price movements without actually transacting the stocks per se.  You simply can buy an option, wait for its value to rise, and then sell it away nearer its expiry date.

 

At the same time, by purchasing options, assuming you do not exercise them, your maximum downside would be the total premium or price you have paid for your options.  This ends up being far cheaper than buying the underlying stock directly.

For instance, rather than purchase 100 Meta stocks (which would cost a few thousand dollars), I could purchase options on Meta, which, at perhaps $20 or $30, would cost me only a fraction of the total value of shares.

There are several reasons why options are a wilder asset class.  Firstly, and similar to Crypto and Forex, there is greater variance in returns.  How so?  

Suppose I am looking at Facebook's stock now, which is available for purchase at $150.  Let's also say that I am not 100% sure of Facebook's upcoming price movements, but I believe it will be bullish (positive). 

 

I purchase a 3-month maturity call option for Facebook for $10,  which entitles me to subsequently purchase 1 Facebook share for $155.

Let's say that 3 months after purchasing the call option, before the maturity of the option, Facebook's stock price rises by 30%, to $180

 

This means that I have correctly anticipated Facebook's price movement. 

 

By this time, my call option will likely be priced almost equivalent to its intrinsic value, which (at least for call options) is calculated as:

Current stock price – Exercise price = $180 - $155 = $25

My total profit from selling my call option on the market will be: 

$25 – $10 = $15

By simply buying and selling a call option – without ever buying or selling a single Facebook share – I have gotten a $15/$10 = 150% return on investment. 

 

Compare this with the scenario where I purchased and sold the Facebook share directly.  In this case, I would have only gotten a 30% return – the % rise in Facebook's share price.

 

The above example hopefully illustrates the volatility in your returns – although, and I emphasize this, this example is a very basic one. 

 

I will provide more discussion on options in a separate article, so do keep your eyes peeled!

  

Apart from price volatility, there is a great variety of option types to choose from, as well as strategies which can be adopted for options (you can buy or sell options), which adds additional layers of decision-making beyond just choosing which stock/asset to focus on. 

 

For instance, apart from the usual long calls and long puts (which I have highlighted above), you also have other exotic options, such as chooser options, barrier options, compound options, and even rainbow options (I'm not joking, just Google it).  

 

It is thus clear to see how an additional layer of decision making gets factored in when dealing with options, making them more complicated as a whole, as an asset class.

Last but not least, as I hinted above, options have an expiration date, by which they must be exercised, or they become void (aka worthless). 

 

Should an investor forget this date (or fail to appropriately exercise the option by its maturity), they will lose their premium paid, which is the price of the option. 

 

The expiry date is also unforgiving in a sense that, even if the stock's price changes drastically the next day to make an option worth the money, once expired, the investor cannot do anything about it.

4.  Daily Leverage Certificates (DLCs)

Daily leverage certificates allow investors to reap gains of a fixed multiple, based on a stock’s price rises or falls within a day. 

 

DLCs can be bought and sold using your usual brokerage platforms, BUT, as a structured investment product, you will likely need to show proof of knowledge or experience trading these assets before you are eligible to transact them.  

 

The beauty of DLCs is that investors can achieve a more than proportionate gain on a stock’s price change, without actually using leverage

 

Most DLCs offer between 3x and 7x (leveraged) returns on the underlying stock’s/index’s performance, and can be either “Long” or “Short”. 

 

“Long” DLCs provide great returns when a stock's price RISES – for instance, the price of the 3x Long DLC will increase by 3% when the underlying stock’s price increases by 1%.

 

HOWEVER, on the flip side, if the stock’s price decreases 1%, then the investor is hit disproportionately hard – the DLC will fall by 3%

 

The converse applies to “Short” DLCs, which increase in price (% wise) by a fixed multiple of the underlying stock’s price decrease (% wise).

Thus, while DLCs can be bought without leverage, they effectively expose investors to the effects of leverage – that is, disproportionate price volatility.

5.  Contracts for Difference (CFDs)

CFDs, similar to options, allow investors to speculate on price movements of an underlying asset, typically stocks.  Unlike options, however, CFDs do NOT have an expiration date

 

At the same time, trading of CFDs is normally done "over the counter", between a client and a broker directly.

The key risk factors for CFDs include:

 

1.  Leverage CFDs are traded on margin, which means that price volatility can be lethal for the investor (the prospective loss an investor may need to deal with may exceed their originally invested principle sum)

 

2.  CFDs, like options, can be long or short – an additional layer of complexity in decision making, besides the fact that this is not the primary company's stock owned

 

3.  Should an investor be unable to respond to margin calls  which occur when the value of the CFD contract has fallen far enough, requiring the investor to top up money in their CFD account  their positions can be forcefully closed out (liquidated)

 

Point #3 means that their broker is able to force sell part of the investor's assets to make up for the shortfall in required funds, which may or may not represent the realisation of heavy losses.

Conclusion

Apart from the more "normal" asset classes out there, there also exists several other more complicated, more volatile asset classes. 

 

Given their key elements – especially volatility, variety, and the additional decision-making layer they add for investors – it is important to be particularly cautious if you ever would like to trade these assets.

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