A very simple definition of options leverage is the ability to control trading assets worth much more than the amount of money you actually have to trade with. 

Investors who do not understand the difference between the above two definitions will eventually find out just how powerful a force it is.

BREAKING DOWN 'Leverage' 

Call options utilize risk-adjusted leverage that enables you to greatly magnify the return (or loss) on money invested. Buying a Call option on a stock gives you the right, but not the obligation, to purchase that security at a given price.

To truly understand leverage in greater detail, you need to understand how it's calculated, which we have explained below. A common misconception is that the leverage factor is then ten and you would therefore make ten times as much money.

However, that isn't actually the case. The price of options contracts actually only moves a fraction of the amount that the price of the underlying security moves by. To understand how the price of options move in relation to the underlying security, you should be familiar with moneyness and how that affects one of the options Greeks: The moneyness of options contracts relates to how much theoretical profit is currently built in to those contracts.

There are three states of moneyness: In the money means the strike price is favorable compared to the price of the underlying security: At the money contracts are where the strike price is equal to the price of the underlying security, and out of the money contracts are where the strike price is unfavorable compared to the price of the underlying security.

The Delta value of an option is the ratio at which the price of the contract moves compared to the price of the underlying security. For example, the price of a contract with a delta value of 0. In the money options contracts typically have a higher delta value than at the money contracts; they usually have a higher delta value than out of the money contracts.

Once you understand all this, it's actually relatively straightforward to calculate leverage and determine how you want to use it when trading. The calculation for leverage is as follows: Options Leverage - Interpretation Understanding options leverage multiple is essential in option trading as the higher the options leverage multiple, the higher the risk of loss!

Following up from our above example: Even though the out of the money options offers 49 times more profit, it can also inflict 49 times the losses to the extend of wiping out all the money invested should XYZ company fails to move beyond it's strike price by expiration! A quick rule of thumb gauge of how dangerous your option plays are in accordance to options leverage on directional call and put option trading, developed by Masters 'O' Equity , is represented in the diagram below: The above is ony an unempirical, rule of thumb gauge, allowing option traders to see if they are threading in the proverbial red zone.

Options Leverage - Applications Options Leverage multiple is essential in option trading for: Trading System Development Important Disclaimer: Options involve risk and are not suitable for all investors.

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Calculating Leverage 

Options Leverage - Calculation The problem with the above illustration of options leverage is that even though 5 contracts of the $50 strike price call options represents shares of XYZ company, it does not move in exactly the .

Divided by the Price of Option ($2) = 5. Therefore the leverage factor of these options contracts is 5, allowing you to make five times as much profit through buying options contracts as you would through buying the stock. Financial leverage is one of the biggest benefits of trading options. Leverage is created by making your investments work harder for you to maximize profit. In other words, leveraging is creating potential for bigger gains using a smaller amount of capital. 

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Leverage refers to taking on debt, while margin is debt or borrowed money a firm uses to invest in other financial instruments. A margin account allows you to borrow money from a broker for a fixed interest rate to purchase securities, options or futures contracts in the anticipation of receiving substantially high returns. How Delta affects leverage To make the issue somewhat more complicated, there is the small issue of options Delta, i.e. the percentage change in the option price as a result of one dollar movement in the price of the underlying share, currency or commodity.

Options Leverage is the cash equivalent multiple of one's options position relative to the actual cash price of the underlying asset. Options Leverage Formula You can calculate the options leverage multiple of your stock options position with the Options Leverage . For example, say a stock is trading for $ and a $ call is trading for $5. One way to view the leverage is to realize that the option trader, in this example, has leveraged the returns by a factor of

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