How exactly does options leverage work?
Options produce options leverage as every contract represents a unit of the underlying asset while costing only a fraction of the price. This allows options traders to control the exposures on the same number of assets but at a much lower cost.
In this short example below, we demonstrate how an American Option works, the same as in the FinNexus Protocol for Options v1.0.
Here’s an Options Leverage illustration:
Assuming you have $1000 and wish to invest in ETH. ETH is trading at $2000 while its $2000 strike price call option is asking for $100. In this case, you could simply buy ETH with all your money and own 0.5 unit of ETH or you can buy 10 contracts of $2000 strike call options on ETH which tracks 10 ETH! With the same amount of money, you can control 20 times more ETH exposure than you normally can by buying ETH. That’s one way of how the options leverage works in options trading.
Following the example above:
If the ETH price grows by 20% to $2400, if you are holding 0.5 units of ETH, then your profit in USD would be $200.
However, if you are holding 10 calls on ETH, by exercising the call, your profit is 10*(2400-2000)-1000=$3000. The rate of return is 3000/1000*100%=300%. The actual leverage in return is 300%/20%=15x.
You are automatically exposed to a leveraged position by holding a call.
If the ETH price grows by 10% to $2200, by exercising the call, your profit is 10*(2200-2000)-1000=$1000. The rate of return is 1000/1000*100%=100%. The actual leverage in return is 100%/10%=10x.
If the ETH price grows by 30% to $2600, by exercising the call, your profit is 10*(2600-2000)-1000=$5000. The rate of return is 5000/1000*100%=500%. The actual leverage in return is 500%/30%=16.67x.
You see the real leverage is not a fixed amount and changeable according to the price movement of the underlying assets.
Please check here for calculation.