What does leverage mean in business

Leverage: This is how you can get even more out of stocks

As a rule, annual returns of 7 to 8% can be achieved with stocks. But there is an even better way: With options, a leverage effect can be achieved on stocks, which can lead to an even higher return.

There are some basic aspects to consider, because leveraging stocks not only has advantages, but also involves risks. First of all, it is important to understand the principles of stock leverage.

Leverage in stocks - what is it?

Many private investors do not know exactly what leverage is in stocks and how it works. On the stock exchange, investors not only have the option of investing directly in a commodity, currency or share (base value), but also use so-called derivatives to secure the purchase of an base value at a fixed price.

The advantage: When buying a derivative, such as an option, investors have to invest significantly less capital than with a direct investment.

Leverage in stocks - an example

Here is a simple example: The shares of Deutsche Telekom AG are supposed to be quoted at € 15. An investor not only buys 100 Telekom shares (15 x 100 = € 1,500), but also invests in 100 call options, with which the investor acquires the right to purchase 100 Deutsche Telekom AG shares within one year at a price of 17 € available.

For the corresponding call options, the investor pays € 1.50, which adds up to the capital employed to € 150. The call options are traded on the stock exchange and have a leverage of 10, with which the investor benefits de facto in a ratio of 1:10 from the rising share price of the base value (Telekom shares).

If the Deutsche Telekom AG share rises by 10% to € 16.50 in the corresponding year, the investor can not only realize a book profit of € 150. The value of the option also increases by 100% from € 1.50 to € 3.0.

This means that the 100 purchase options on the stock exchange are worth € 300 and, in this fictitious example, the investor can reap a total profit of € 300 (€ 150 + € 150) after deducting the investment costs.

It should be noted, however, that the leverage also applies in the opposite direction. If the underlying loses 5% in our example, the option loses 50% of its value. In practice, this can even lead to a total loss of the capital invested in the call options if the underlying does not develop in the hoped-for direction.

The leverage and influencing factors

In practice, other key figures such as remaining term, omega and delta influence the leverage effect and thus have an enormous influence on the price development of the option or the warrant.

An important role in the selection of options is played by the omega leverage, which indicates the actual leverage of the option. The Omega lever shows the investor the percentage by which the option or warrant increases if the value of the underlying changes by 1%.

In principle, experience has shown that options with low leverage are less volatile than options with high leverage and are therefore better suited to investors in the learning phase who do not yet have much experience with derivatives.

Investors should also know the difference between an option and a warrant. There is no issuer for the option (call or put). In this case, there is therefore no risk of price manipulation and the risk of the issuer becoming insolvent.

Conclusion: Leveraging stocks opens up additional opportunities for returns, but it is also highly risky

Overall, it should be noted that leverage products are high-risk and investors must expect a total loss if the underlying does not move in the desired direction. Therefore, leveraging stocks is only interesting for speculatively oriented investors or for professionals who want to hedge existing positions.

With the right strategy, money can be made in option transactions, but the risk of the writer should not be underestimated. > read more

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