Why Do They Say Options Are Leveraged?
The word “leverage” comes from the word lever, which is a tool to magnify one’s force and thereby improve efficiency.
Options are leveraged because they magnify the efficient use of capital.
Let’s see how.
Contents
A stock trader buys 10 shares of IBM on August 15th, 2025, and sells it on September 4th:
Buys 10 shares at $238.58 / share: -$2386
Sells 10 shares at $244.25 / share: $2443
Net profit: $57
Net yield: $57 / $2386 = 2.4%
He made a profit of $57 but had to use $2386 in capital to buy the stock.
That is a 2.4% return on investment.
Now, an options trader buys three contracts of the following call options on August 15th and sells them on September 4th.
The call option has a strike price of $245 (slightly out of the money) and expires on October 17, with 63 days to expiration.
It costs $7.45 per share or $745 per contract.
Therefore, buying three contracts will require about the same capital as buying the stock.
Buy three contracts at $7.45/share: -$2235
Sell three contracts at $8.00/share: $2400
Net profit: $165
Net yield: $165 / $2235 = 7.4%
The two investors bought and sold at the same time, with IBM moving up the same amount.
But the option investor made more money.
This is what is meant by leveraged.
You get an amplified return on the same amount of capital used.
A call spread trader buys four contracts of an at-the-money call spread:
Buy four contracts Oct 17 IBM $235 call @ $12.60
Sell four contracts Oct 17 IBM $245 call @ $7.45
Net Debit: -$515 x 4 = -$2060
On September 4th, he exits the spread for a credit of $6.30/share, or $630 per contract:
Sell four contracts Oct 17 IBM 235 call @ $14.30
Buy four contracts Oct 17 IBM 245 call @ $8.00
Net Credit: $630 x 4 = $2520
So the net profit is $460.
Net yield is $460 / $2060 = 22%
The call spread is an even more efficient use of capital, generating 22% return on the capital at risk.
Note that at no point is the call spread risking more than $2060.
Here is an option seller of a put spread:
Buy six contracts Oct 17 IBM 220 put @ $2.98
Sell six contracts Oct 17 IBM 225 put @ $4.03
Net Credit: $105 x 6 = $630
The put spread is an out-of-the-money put spread, which he buys back to exit the trade on September 4th:
Sell six Oct 17 IBM 220 put @ $1.22
Buy six Oct 17 IBM 225 put @ $1.79
Net debit: -$57 x 6 = -$342
Net profit: $630 – $342 = $288
Since the max risk in this trade is $2370, the yield on this trade is
$288 / $2370 = 12.15%
What if IBM had gone down to $230 and the trade is a loss?
In that case, the option traders would have lost more money than the stock trader.
Profit and loss with the nearly same amount of capital used:
Options allow traders to leverage their capital.
It increases gain, but it also increases losses.
Traders who are good at correctly analysing direction can achieve a higher return on capital.
But options require additional study to master their complexity.
For example, if a trader selects a call option with the wrong strike price and expiration, they can still lose money even if they get the direction right.
Ultimately, options can be powerful tools, provided that they are used with a good understanding of their profit and risk behaviors.
We hope you enjoyed this article on why options are considered leveraged.
If you have any questions, please send an email or leave a comment below.
Trade safe!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
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