Another appeal of options is the
leverage
that they offer. When you leverage an investment, you use a small
amount of money to control an investment that's worth much
more. Leverage means that you can do more with the money you have.
With options, you get leverage because you control
100 shares of stock for only the cost of the
premium,
which is generally much less than the cost of the shares themselves.
For example, if you purchase a
call,
you could profit from an increase in the underlying stock's
price at a lower cost than if you owned the shares and they gained
value.
Percentage returns
Leverage means that if you calculate the return
you make on an investment as a percentage of the original investment,
successful options trades usually have relatively high percentage
returns. And if you make an unprofitable trade, you've risked
less of your capital to make it.
For example, if you invested $200 and had a return
of $300, you made $100. That might seem like a small amount, but
since you made that $100 from only a $200 investment, your return
was 50%, which is relatively high.
As a tradeoff, however, leverage means that losses,
as a percentage of your original investment, can be relatively
high as well. As an options holder, it's very possible to
lose your entire investment if the option expires worthless.
