DATE: July 29, 2013
Can you explain the term leverage as it relates to options trading?
The term leverage can be defined as "profits or losses that can occur when the percentage profit or loss is greater than the percentage change in price of the asset." Leveraged profits can result from borrowing, such as buying stock on margin. In this definition, it's important to focus on the word percentage. If a stock price rises or falls by 10%, and your profit or loss is 20%, then your exposure to that stock was leveraged in some way.
While leverage can be a useful tool for many traders, there is ALWAYS a tradeoff. Depending on how leverage is used, the price a trader pays for reducing an initial investment or for controlling more shares may have a greater percentage risk or more frequent losses, or both. To learn more about the term leverage, view this segment of "Ask the Institute."