Gearing

Also known as Leverage


If you buy a far "out of the money" option it may not be worth very much, especially if there is not very long until it expires
If the option expires wothless, then you also have not lost very much
However if there is a dramatic move in the underlying, so that the option expires in the money, you would make a large profit relative to the amount you invested.


Example

Today is the 1st July and the price of Better Solutions stock is $666
The cost of a $680 call option with an expiry of 20 July is $39.
I expect the stock to rise significantly between now and the end of July.
How much profit can I make if the share price i3 $730 on 20 July.


From buying the stock
I buy the stock at $666 on 1 July and then sell it on 20 July at $730
I have made a profit of (730 - 666) = $64
This expressed as percentage is as follows:
( (730 - 666) / 666 ) * 100 = 9.6%




From buying the call option
I buy the 680 call option for $39 on 1 July and then sell the stock on 20 July at $730
I have made a profit of (730 - 680) = $50
This expressed as percentage is as follows:
( (730 - 680 - 39) / 39 ) *100 = 28%


The out of the money option has a high gearing
The downside to this extra gearing thought is that there is ahigh probability that the call option will expire completely worthless.






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