How Does the Concept of “Leverage” Apply to Options Trading?
Options provide leverage because a small premium payment controls a much larger value of the underlying asset, typically 100 shares per contract. A small percentage change in the underlying asset's price can lead to a much larger percentage change in the option's price.
This allows traders to potentially achieve higher returns on capital compared to buying the underlying asset directly. However, leverage also amplifies potential losses.
Glossar
Underlying Asset
Foundation ⎊ The concept of an Underlying Asset, within cryptocurrency derivatives and financial markets, establishes the core reference point for valuation and risk transfer.
Options
Hedging ⎊ The primary strategic application of these instruments, allowing market participants to offset potential adverse price movements in their underlying crypto holdings.
Option Premium
Cost ⎊ The Option Premium represents the initial cost paid by the buyer to acquire the right conveyed by the contract, functioning as the price for risk transfer.
Premium
Price ⎊ In the context of options trading, the premium represents the price paid by the option buyer to the seller for the rights conveyed by the contract.
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.