Understanding Leverage. 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. Buying options contracts allows you to control a greater amount of the underlying security, such as stocks, than you could by actually trading the stocks themselves. Put simply, if you had a certain amount of capital to invest then you can create the potential for far higher profits through buying options than you could through buying stocks. This is essentially because the cost of options contracts is typically much lower than the cost of their underlying security, and yet you can benefit from price movements in the underlying security in the same way. LetЂ™s assume that you had $1,000 to invest, and you wished to invest in Company X stock because you believed it was going to increase in price. If Company X stock was trading at $20, then you could purchase 50 shares in Company X with your $1,000. If the stock went up in value, then you would be able to sell those shares for a profit. For example, if they went up by $5 to $25 then you could sell them at $5 profit per share for a total profit of $250 (not accounting for any commissions on your trades). Now letЂ™s assume you decided to invest in call options on Company X Stock, trading at $2, with a strike price of $20. If the contract size was 100 you could buy five contracts at $200 each: meaning you effectively have control over 500 shares in Company X (5 contracts, each covering 100 shares).
This would mean that using your $1,000 to buy options has given you control of 10 times as many shares as using your $1,000 to directly buy shares at $20 a time.