Concept of leverage

[haiderraza]

Leverage can be created through options, futures, margin and other financial instruments. For example, say you have $1,000 to invest. This amount could be invested in 10 shares of Microsoft stock, but to increase leverage, you could invest the $1,000 in five options contracts. You would then control 500 shares instead of just 10.
Can somebody pls explain this example. How are we controlling 500 shares instead of 10 shares.

 

[haiderraza]

Increase in leverage utilization via commodity futures will greatly affect oil price movements. With return of leverage, volatility in oil prices will increase and oil prices may not be able to find a sustainable equilibrium.

Pls explain this. How the magnitude of effect on prices is increased when we use futures?

 

[MrSmart]

haiderraza wrote:
Leverage can be created through options, futures, margin and other financial instruments. For example, say you have $1,000 to invest. This amount could be invested in 10 shares of Microsoft stock, but to increase leverage, you could invest the $1,000 in five options contracts. You would then control 500 shares instead of just 10.
Can somebody pls explain this example. How are we controlling 500 shares instead of 10 shares.

Because options do not need the underlying asset to be in your possesion. An option for one stock is a fraction of it’s value, and gets the payoff as the difference between the strike price and current market price if profitable for the holder. So essentially, you could leverage on short term price movements of more than 10 stocks by using options on 500 stocks.

haiderraza wrote:
Increase in leverage utilization via commodity futures will greatly affect oil price movements. With return of leverage, volatility in oil prices will increase and oil prices may not be able to find a sustainable equilibrium.

Pls explain this. How the magnitude of effect on prices is increased when we use futures?

I don’t know to be honest.
If I had to guess, a highly leveraged commodity like oil would see more volatile price movements because it’s price may be fixed on the global market due to a large volume of future contracts, so the price discovery of supply and demand is not fluid, and shock movements may occur.

 

[leveRAGE]

haiderraza wrote:
Leverage can be created through options, futures, margin and other financial instruments. For example, say you have $1,000 to invest. This amount could be invested in 10 shares of Microsoft stock, but to increase leverage, you could invest the $1,000 in five options contracts. You would then control 500 shares instead of just 10.
Can somebody pls explain this example. How are we controlling 500 shares instead of 10 shares.

this is an odd hypothetical example where microsoft is trading for $100 and the “options” are trading for $2, but the basic gist is that 1 (call) option contract gives you the right to buy 100 shares of MSFT at a given price (the strike price). so if msft was trading at $100 and some “option” (need more detail here…maybe assume the at the money option) was trading for $2(then multiplied by the 100x share qty), you could either buy 10 shares (and control 10 shares of MSFT) or 5 option contracts and “control” 500 shares. this example is missing a lot of necessary detail to actually make it make sense, but thats what its saying.