Lesson 9 of 10 · All lessons in this module
- Financial assets, yields and expected versus actual returns
- What an interest rate is made of
- Required return, risk premia and excess returns
- Holding period return
- Arithmetic and geometric mean returns
- Annualised and continuously compounded returnsVideo lesson
- Gross, net, after-tax, real and leveraged returnsVideo lesson
- Taxing price and income returns
- Leverage through call options
- Integrated cases: from total return to what the investor keeps
This lesson is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.
Lesson 9 of 10 · 11 min
Leverage through call options
A call option gives exposure to a share for a small premium, so percentage gains and losses are far larger than on the share itself, and the whole premium is lost unless the price ends above the strike.
In short
- A derivative takes its value from an underlying asset. A call option gives the right, not the obligation, to buy the underlying at the strike price; its price is the premium.
- At expiry the call is worth max(S − strike, 0); the buyer's return is (value − premium) ÷ premium.
- Break-even for the call buyer: strike + premium. At or below the strike the buyer loses 100%.
- Like borrowing, options magnify gains and losses; the loss is capped at the premium but is hit even if the share merely stays flat.
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