Using the Power of Leverage with Options Trading

Anyone who has a position in a market wants to have the most leverage possible. This helps to protect your position, and limit your exposure to unwanted or financially devastating moves in that market's price. Trading options can provide you with this leverage.

For example, if you buy 100 shares of a stock trading at $30 per share, you have just invested $3,000. If you were to buy an options contract based on that same stock with a price of $2.00 per share, you would pay just $200. Although buying the option is not buying the stock, the option gives you the right to buy that stock within the contract period for $30.00 per share. If you feel that the stock price will increase over the time period of your options contract, you can then enjoy a profit. If the stock increases to $40 per share within your options contract period, you can then buy the stock for $30 per share. You now have made a profit of $10 per share or $1,000, particularly if you immediately sell the stock back into the market.

You can also use options to provide leverage for current positions you have in an underlying asset. Let's say you currently own 100 shares of a stock currently trading at $50.00, but all your analysis predicts a decline in that market over the next couple of months. You can purchase put options with a $50.00 strike price. These put options will enable you to sell your stock at $50.00 within the options contract period. This would protect you from a big loss if the market does decline. If the price of the underlying asset increases, you can allow the put options to expire and you still maintain your current position in that underlying asset. Your only financial risk is the cost of buying the put options. Additionally, if you only paid $48 per share for the underlying asset, and the price declines, you will be able to profit as well, depending on the commissions paid to enter and exit the market.

These are only two simple examples of how options trading can provide you with leverage in the markets.