Explain the Concept of ‘Leverage’ in Derivatives Trading.
Leverage is the use of borrowed capital to increase the potential return of an investment. In derivatives trading (futures and options), it allows a trader to control a large notional value of an underlying asset with a relatively small amount of capital (margin).
While leverage magnifies potential profits, it also equally magnifies potential losses. It is a double-edged sword that requires careful risk management.
Glossar
Derivatives Trading
Leverage ⎊ Derivatives trading, within cryptocurrency, options, and financial markets, fundamentally represents a contractual agreement where value is derived from an underlying asset, enabling amplified exposure without necessitating outright ownership.
Notional Value
Scale ⎊ Notional Value refers to the total market value of the underlying asset controlled by a derivatives position, calculated by multiplying the contract size by the current market price, irrespective of the actual margin capital posted.
Leverage
Amplification ⎊ Leverage, within cryptocurrency, options, and derivatives, represents the utilization of borrowed capital to increase the potential return of an investment, fundamentally altering risk-reward profiles.
Borrowed Capital
Leverage ⎊ Borrowed capital refers to funds acquired from an external source to augment an investor's trading capacity.