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No. of Recommendations: 32
I think that what you are missing is that when the lows for the year are in positive territory it doesn't matter so much but when you hit negative territory the leverage can kill you. For example, if I am down 20% YTD and you are down 30% because of more leverage, it will take me a 25% gain to get back to breakeven from 80, while it will take you a 43% gain to come back from 70 to breakeven (100).

And the worse the drop the greater the difference. To come back from a 40% loss it takes a 67% gain, and from a from a 50% loss it takes a 100% gain to come back to breakeven.


The are different ways to "leverage". There can be leverage using money that you don't have to buy stocks. In this case, you are correct that you can get wiped out. Another form of "leverage" (I'm using the term loosely) is to buy call options instead of buying stock. In this case, you're not really leveraged because you're not actually borrowing money. You are basically controlling more shares by buying options instead of shares. The loss of call options on equities is limited to your investment so call options can only be worth zero. This is not like your experience with futures trading where the loss can be unlimited. There are many forms of so-called leverage and they are not all equally bad or dangerous.

As an example, I could buy 100 shares of AYX for about $10,500. Or I could buy 1 contract (which controls 100 shares of AYX) for about $3200. This contract gives the buyer the right to buy 100 shares of AYX for $105 anytime before January 21, 2022; the cost of this right is about $32 per share. So for the same price as I would pay to buy 100 shares, I could buy 3 such contracts which is roughly equivalent to 300 shares. The 3 contracts would cost $9600.

So the option holder would have between now and January 21, 2020 to buy the 300 shares for a fixed price of $105 per share.



Cost @$105 @$120 @$137 @$155 @$180 @$300
VALUE
Shares $10,500 $10,500 $12,000 $13,700 $15,500 $18,000 $30,000
Options $9,600 $0 $4,500 $9,600 $15,000 $22,500 $58,500

% GAIN
Shares $10,500 +0% +14.3% +30.5% +47.6% +71.4% +185.7%
Options $9,600 -100% -53.2% +0.0% +56.3% +134.4% +409.4%


From the table above, you can see the payoff table. I understand that I can lose my entire $9600 investment in the options (but no more than that). In this example, if AYX shares are above $152 seven quarters from now (or before), the options yield a higher return.

Chris
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