Benefit from Options Leverage
In this post we will give you an Understanding options leverage and show you how to profit from it. Leverage can be very powerful when it comes to investing because by using leverage it’s possible to turn relatively small amounts of capital into significant profits. With many financial instruments, such as stocks, the only way to take advantage of leverage is to borrow funds to take a position and this isn’t always possible for everyone. With some instruments, though, leverage is possible in other ways.
One of the biggest benefits of trading options is that options contracts themselves are a leverage tool, and they allow you to greatly multiply the power of your starting capital. On this page we look at exactly how leverage works in options trading and how it’s calculated.
Leverage in options
If you use options in trading you do not have to have much capital. In the next example we compare buying stock against buying options.
Let us look at the following example Facebook is trading at $55, The option price of a $60 Strike March call is $3. The stock prices moves up to $70 by expiration. We compare the performance of the stock with the call:
Stock will gain $15 ($70-$55) that is an rise 27%. The Call option will gain $7 that is a 233% ($70-$60-$3) move. Therefore, given the scenario above, an investor would spend $5,500 to buy 100 shares of Facebook and realize a gain of $1,500.
An option trader that buys only 2 call contracts and spend $600 ($3 X 100 shares X 2 contracts) He/she realizes a gain of $1,400 ($7 X 100 shares X 2 contracts) which is about the same gain as the stock investor who spent $5,500! The worst thing that can happen to the option trade is that he loses his $600 investment.
Leverage in selling options
In the above example we were calculating the profit in an upward going market. Instead of buying a call you can consider of selling a put. You will receive credit in advance. Your profit will not more than the option premium received. But your changes on a profit are much higher. If the stock goes up you can keep the premium at expiration. And even if the stock price moves does not move much or stays flat you can keep the premium. Even the price move down until break even you did not loose a penny. This in contrary if you bought the stock you loose penny for penny when the stock moves down.
In the above example an investor who buys 100 shares of Facebook will pay $5.500. On the other hand an option traders buys 2 options FB for only $600. They both realize the approximately the same profit only the option trader payed 90% less.
Selling options will increase your probability of profit. And 2 out of 3 market moves you will make money.