How Can the Use of Leverage in Derivatives Amplify Both Gains and Losses in an Arbitrage Trade?

Leverage allows a trader to control a large position with a small amount of capital. In an arbitrage trade, where profit margins are typically very thin, leverage can magnify a small percentage gain into a substantial return on capital.

However, it is a double-edged sword. The same magnification effect applies to losses.

A small, unexpected price movement against the position can be amplified into a loss that exceeds the initial capital, leading to a margin call or complete liquidation of the position.