noun --- lev·er·age --- 1. the action of a lever, a rigid bar that pivots about one point and that is used to move an object at a second point by a force applied at a third."/>


Whether we realize it or not, from the time we are little we make use of leverage. In the simplest of terms leverage is defined as:



1. the action of a lever, a rigid bar that pivots about one point and that is used to move an object at a second point by a force applied at a third.

2. the mechanical advantage or power gained by using a lever.

3. power or ability to act or to influence people, events, decisions,etc.; sway: Being the only industry in town gave the company considerable leverage in its union negotiations. Synonyms:advantage, strength, weight; clout, pull.

4. the use of a small initial investment, credit, or borrowed funds to gain a very high return in relation to one’s investment, to control a much larger investment, or to reduce one’s own liability for any loss.

verb (used with object)

5. to exert power or influence on.

6. to use (a quality or advantage) to obtain a desired effect or result: She was able to leverage her travel experience and her gift for languages to get a job as a translator.

7. to provide with leverage: The board of directors plans to leverage two failing branches of the company with an influx of cash.

8. to invest or arrange (invested funds) using leverage.


English: a simple 3D illustration to show leve...

For most of us, our first introduction to leverage occurs when our moms and/or dads take us to our first playground and plop us down on a seesaw. We master our use of leverage when we eventually learn how to propel our younger brother or sister off the other end of the seesaw by manipulating the power afforded us by a lever (i.e. the seesaw). 😀

As time passes, we further learn the power of leverage when we learn how to manipulate our parents to get those things we want (call it the ‘cute factor’). And, the ultimate lesson in leverage comes later in life when we obtain our first credit card, our first car loan and, then, our first mortgage (i.e. for those of us who are lucky enough to qualify for a home loan).

As many of us learn, leverage can be a good thing. It provides opportunities that we normally would not have available to us. Without the use of levers and leverage we wouldn’t be able to move mountains or purchase those things we desire — those items that are just beyond our reach because of the limitations of our income and/or our savings. It is here where the rubber meets to road. burning_bubber

When it comes to our finances leverage, in the form of loans, can be a blessing (or a curse). Having the ability to borrow, whether through our credit cards, a bank loan or through margin loans in our investment accounts, gives us the opportunity to attain things that would, otherwise, be out of our reach. Leverage or, more specifically, credit affords us opportunities that so many people throughout the world simply don’t have. Having the ability to borrow is what gives people in in developed countries the ability to live richer and fuller lives — lives that, in certain cases, may be well  beyond a person’s means.

animated_flashing_construction_barracade As with anything in life, opportunities come with a price and with certain risk factors. Personally, I have three margin accounts with various online brokers, and each account serves different needs. The reason I specifically opened margin accounts is because I wanted to have the ability to short stocks (short selling) and other investment instruments if I so chose. (Note: In order to sell stocks or any other trading instrument short , like ETFs, one must have a margin account.) However, I never trade on margin — it’s simply too dangerous! It is the one form of leverage that I don’t like to mess with when it comes to my investments or trades. For me, when I want to use leverage, the better choice has been the use of options, because of the ability they give me to define my potential losses.

For example: jnj_02-20-13

At present, Johnson & Johnson (JNJ) is selling for $76.94 per share, and the price appears to be on the rise. If I believed that JNJ’s price will continue its current uptrend, and I wanted to purchase its stock, I could either buy the shares outright or I could purchase Call options.

If I were to purchase 100 shares of JNJ outright, the cost to me would be $7,694.00 (not including commissions and fees). With that same $7,694.00, however, I could purchase thirty-nine MAR 13 75.00 Calls for $1.94 (the current “Ask” price).


Now what does all of that mean?

Essentially, with the same $7,694.00 investment I am able to purchase 39 Call contracts which give me the right (but not the obligation) to purchase 3,900 shares of JNJ for $75.00 apiece. So, why would I want to do that? I can’t afford 3,900 shares of JNJ (3900 x 75.00 = 292,500)! Well, because you don’t have to buy them. Remember, Call options give you the right (but not the obligation) to purchase the shares at the specified price, at a specified time in the future (i.e. the Exercise Date).

Many options traders use this strategy, and other various options strategies, to leverage-up their trades. In this example, the trader is, effectively, increasing his or her trade from 100 shares of JNJ to 3,900 shares! If the price of the stock increases (our original premise) then the price of the Calls will also increase. Thus, if the Calls increase in value from $1.94 per contract to, let’s say, $2.15 per contract, the trader could then sell the Calls and pocket $819.00 in profit (2.15 – 1.94 x 39 x 100 = 819.00) — less commissions and fees.

The numbers read like this: 2.15 (Sale Price) – 1.94 (Orig. Purchase Price) x 39 (Total Number of Contracts) x 100 (Multiplier) = 819.00 (Profit). Note: The Multiplier is the number of shares that each contract represents. Generally speaking, options contracts represent the “option” to buy or sell 100 shares of a given stock — in this case JNJ.

So, as you can see, options make use of leverage in a BIG way. With our initial investment of $7,694.00 we are given the ability to “leverage-up” our trade to $292,000.00 worth of JNJ’s stock. Fair warning, however, this type of trade can lose money, too! Given that JNJ’s stock could easily turn and head in the opposite direction, this type of trade could leave an investor/trader with losses and no hope of recovery (i.e. the trader would not own any shares of JNJ outright, so there is no hope of price recovery). The benefit to this type of trade, however, is that the trader knows, in advance, how much capital is at risk. Remember, too, that a trader can always exit the options trade and any point; thus, further minimizing his or her risks.

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