What are knock-outs and how to trade them
A knock-out is a limited-risk CFD which has features that help you to manage your risk and margin. Discover everything you need to know about knock-outs, including how they work and how to trade them.
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What are knock-outs?
Knock-outs are a limited-risk CFD trade with an expiry. They automatically close – or get ‘knocked out’ – if your provider’s underlying market price reaches your knock-out level. They move one-for-one with the underlying market – meaning that for every point the underlying market moves, the price of the knock-out moves by the same amount.1 By setting your own knock-out level and your trade size, you will be able to manage and control your margin and your risk.
Knock-outs can only be bought to open (not sold to open). To enable you to go long or short on the market price, there are two types of knock-out available: bull and bear.
- You’d buy a bull knock-out if you believe the price of the underlying market will rise
- You’d buy a bear knock-out if you believe the price of the underlying market will fall
In both cases you make a profit if the market moves in your chosen direction, and a loss if the market moves against you. You can close your position at any time before expiry – unless the knock-out level is reached, in which case the position will be automatically closed.
How do I trade knock-outs?
When opening a knock-out position, the first decision you will have to make is whether you are buying a bull or a bear.
If you believe that the market price is going to rise, you’d buy a bull and set a knock-out level below the opening market price. Alternatively, if you believe that the market price is going to fall, you’d buy a bear and set a knock-out level above the opening market price.
You can then select the specific knock-out level at which your position will be closed out if the market goes against your prediction.
Once you have made these two decisions, the opening price of the position will be calculated as follows:
- Bull: (IG’s underlying offer price – knock-out level) + knock-out premium* x size
- Bear: (knock-out level – IG’s underlying bid price) + knock-out premium* x size
*A knock-out premium helps protect against slippage (ie. when a price moves before a trade is closed at your chosen level). You’ll receive it back if you close the trade without the knock-out level being triggered.
Your maximum risk is the opening price multiplied by your stake size, so you can manage and control how much you stand to lose if your position is knocked out.
Example knock-out trade
Let’s say the Hong Kong HS50 is currently trading with an offer price of 26050.1. You decide to go long, by opening a bull position at HK$5 per point with a knock-out level at 25850.1. If the current knock-out premium is 10, the margin you’ll need to pay is as follows:
The knock-out price will move one-for-one with the underlying IG market – so for every point our underlying price moves, the knock-out price moves exactly the same amount.1
- If the HS50 rises and the current bid becomes 26150.1, your running profit would be +HK$500.
- If the HS50 drops and the current bid becomes 25950.1, your running loss would be -HK$500.
- If the HS50 drops to your knock-out level, your realised loss would be -HK$1050, which includes the 10 point knock-out premium.
If the market moves in the way you predict, you could close your knock-out at any time before expiry and collect your profits. You could even set a limit order to close your trade when it has reached your target level of profit.
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1 This is not the case when the knock-out premium changes. If the knock-out premium changes, the price of the knock-out will move by the amount the premium changes.