Why Option Trading? (Part 2)

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3. Leverage

You can potentially have greater % return of investment from options trading than from stock trading, given the same move in the underlying stock price.

For example:
A stock price of Company ABC (currently trading at $96) is expected to increase significantly over the next few weeks. The Call option price for that stock with Strike Price of $95 and 45 days to expiration is $6.
If you buy 100 shares of that stock, you need to invest $9,600 to purchase the stock. Assuming the stock price increases to $105 within 15 days, you would gain $ 900 (= 10,500�9,600) or 9% (= 900/9,600).
But if you buy 1 Call option contract for that stock instead (that gives the right to buy 100 shares), the cost will only be $600. When the stock price rises to $105, the option price may increase to $11 and you can then sell the option with a gain of $ 500 (=1,100�600) or 83% (=500/600).
As you can see, given the same number of shares, you get much higher % return using options (83%) than stocks (9%), although it is smaller in terms of actual dollar.

If, say, you buy 2 contracts of Call option for $1,200, you can gain $1,000, comparable to the dollar gain from the stock investment ($900). So, buying options allow you to gain the same profit as stocks would with only a much smaller capital and, therefore, at a much lower risk than buying stocks. In the worst case, if the stock crashes, the most you can lose is $1,200 and not the full $9,600.