An option is a leveraged instrument. In the case of a long call option, an investor pays a premium to acquire the right to buy shares at a fixed price at a future date. The premium is only a portion of what the investor would pay if he buys then shares outright. If a share price rises by a certain percentage, most long call options on that share will rise by a greater percentage. The money amount of the profit in options may be smaller than that arising from an outright investment in the share itself, but the rate of return may be much greater and the amount of money put at risk can be much less.Of course, the leverage effect also has its downside implications. If the share price drops and makes the call far out-of-the-money, the value of the premium will suffer a larger percentage drop than the share price, notwithstanding that the extent of the loss is limited to the cost of the premium. In addition, the leverage effect can compound geometrically the losses that can occur in relation to short options.
Leverage option
An option is a leveraged instrument. In the case of a long call option, an investor pays a premium to acquire the right to buy shares at a fixed price at a future date. The premium is only a portion of what the investor would pay if he buys then shares outright. If a share price rises by a certain percentage, most long call options on that share will rise by a greater percentage. The money amount of the profit in options may be smaller than that arising from an outright investment in the share itself, but the rate of return may be much greater and the amount of money put at risk can be much less.Of course, the leverage effect also has its downside implications. If the share price drops and makes the call far out-of-the-money, the value of the premium will suffer a larger percentage drop than the share price, notwithstanding that the extent of the loss is limited to the cost of the premium. In addition, the leverage effect can compound geometrically the losses that can occur in relation to short options.