Leverage and Gearing
The words “leverage” and “gearing” are used frequently in the financial world. In terms of a company’s financial structure, it means the ratio of borrowings over assets. The higher a company’s gearing, the higher its return on equity will be, but also the greater risk to the company because if fixed and variable costs are not exceeded by turnover, then the company’s creditors may be able to foreclose the company by calling in the loans.
The words have a similar but not identical meaning in the options world. Options have high leverage because a small percentage move in the underlying asset can mean a very high percentage move from the corresponding options.
How Does Leverage with Options Work?—A Worked Example
Example 2.5. ...
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