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Leverage

Leverage, in the context of options trading, refers to an investor’s ability to trade larger amounts of stocks using a smaller amount of capital. It’s like using a lever to lift more weight than your physical strength allows – hence the term ‘leverage’. It allows you to benefit from a financial gain or loss in stocks without actually owning them. 

In practice, an investor can buy an option contract (which is equivalent to 100 shares of a stock), using significantly less money than it would cost to buy the shares outright. The greater potential for profit comes with a greater risk of losses, as the movement in the price can greatly influence profitability. 

The ratio of the amount of money an investor can potentially make to the initial amount they invest is the leverage ratio. A higher leverage ratio means a larger potential return, but likewise, higher risk. 

So, while leverage provides the potential for substantial gains, it also exposes traders to significant risks, especially if the market doesn’t move in the direction expected by the investor. For this reason, it’s recommended to use leverage thoughtfully and judiciously in investment scenarios.

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