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Ways to Use Call Option As a Leverage in a Portfolio
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Ways to Use Call Option As a Leverage in a Portfolio

by editorMarch 14, 2018

Call options are generally used by the advanced investor but they can also be used to create leverage and also manage risk at times. Using options can be quite complicated at times and therefore call options are the best to explain. To know more about the investment strategy you should read this article which tells you how to use call option as leverage in a portfolio.

What is a call option?

A call option is part of the derivative markets of financial instruments. A call option gives the right to the buyer rather than an obligation, to purchase any commodity or financial instruments agreed upon previously by the buyer in an agreement with the seller of the option. It is the right of the buyer to buy the agreed amount of commodities or financial instruments at any certain fixed rate within a fixed period of determined time.

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Options are that form of derivative instruments used by the investors, mostly retail investors who wish to give a boost or high to their portfolios use this form of leverage. Also, such investors do not want to take the risk of borrowing money and thus choose the path of call options.

With call options, you can get leverage that is risk-adjusted and thus you are able to magnify the returns, whether it be losses or profits.

Let us take an example to explain how call options can be used to provide leverage to and boost to your portfolios. Calls can be explained by a simple example. Let us assume that in August you buy Call for $200 in ABC Company, which trades at $20 that will expire in January with the strike price amount of $30.

If you had to buy that stock out rightly instead, you would be required to come out with $2,000 upfront.  If that stock price now rises to $40, you would make a profit $1,000. However, even after you have bought a Call derivative at $30 instead of $20, you paid only $200. That means you made a profit of $600 from just $200, an astounding gain isn’t it!

Your risk gets reduced when you buy options. Using the above example, let’s assume that the stock price dropped to $10. If you had now bought that stock at $20, you’ll have a loss of $1,000. Because you do not have any obligation to buying the stock for $30 in Call options, you will lose only your initial amount invested.

Also, if you are an owner of stock already, you can also use the call option to provide leverage to your portfolio. Or you can also use call option as a safe haven where you would not have to worry or would not be at any loss even in the case of failure. Options offer you the means to provide leverage in the safest possible way as there are no or minimum risks involved. It is considered as the least risky method to enrich your portfolio. When you use calls, you’ll just put the initial amount invested on risk, rather than larger risks involved in borrowing money. Also, with call options, you have the freedom to choose your course of action and are under no obligation.

Call options also allow the investors to take high risks with small amounts of premium. You can also create unique and innovative strategies to deal and manage your investment when you are using call options, depending upon the market strategies and volatility of the market. The bull call spread is the most common of all the strategies. Depending on the market conditions these strategies can provide varied protection to different users.

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