How to Calculate Leverage
Investors and traders use leverage to increase the profit potential from the money they have to invest. Using leverage involves borrowing money to pay for part of the investment or using a derivative investment to control a larger amount of the primary investment. Examples of leveraged investing are using a mortgage to fund the purchase of investment property or the margin deposit on a futures contract to control a large amount of a commodity or financial asset.
Other People Are Reading
Instructions
-
-
1
Determine or look up the amount of investor money that is required to buy the investment. This is the cash amount an investor must put up. For an investment property it is the down payment. For a stock market option it is the cost or premium of the option contract. Futures contracts have a specified margin deposit amount.
-
2
Determine the market value of the asset or securities controlled by the investment amount. For example, a stock option controls 100 shares of the underlying stock. A futures contract covers a specific amount of the commodity or instrument. An investment property has a purchase price.
-
-
3
Divide the value of the controlled asset by the cost to control that asset from step 1. Some more examples: If an investment property requires a 20 percent down payment, the leverage amount is 5 to 1. A futures contract for $100,000 worth of Treasury bonds has a margin deposit of $3,375, Divide 100,000 by 3,375 to get 30-to-one leverage. An at the money call option on Apple stock has a price of $10.55 and Apple shares are trading at $300. Again, the leverage ratio is 30 to one.
-
1
Tips & Warnings
The leverage ratio is the amount of profit or loss percentage if the controlled asset gains or loses one percent in value.
Stock market investors are allow 2 to 1 leverage in a margin account and 4 to 1 leverage in a designated day trading account.
Leverage works both ways. It can magnify gains or rapidly lead to a wipe out of invested capital. 30 to 1 leverage means an investment only has to drop a little over 3 percent and the investors capital is gone.
