Looking to access our full catalog of shows? Log in to see what's recent and get old favorites!
The notional value of a position is the real amount at risk, excluding margin relief. If we own 100 shares of stock at $50.00 per share, we have $5000 of notional value at risk. If the stock price drops to $0.00, we stand to lose $5000. In a margin account, we are offered 2:1 leverage on stock purchases. What does this mean? Basically, that same 100 shares of stock would only require $2500 of capital to purchase. What we have to remember is that we still have that same $5000 of notional value. In other words, we only have to put up $2500 at first, but if the stock price goes to $0.00 we still lose $5000.
Understanding the difference between leverage & notional value is one of the most important concepts to learn:
When it comes to options, leverage works a little differently. Unlike stock, available buying power doesn’t change. If we deposit $10,000 into my account, our option buying power will be $10,000. If we are in a margin account, the stock buying power will be $20,000. That is how the stock leverage works.
If we’re in a margin account and have full margin for options, the difference lies in the buying power reduction (BPR).
Let’s say we sell a put at the $50 strike, when the stock price is trading at $55.00. In an IRA account, which is cash secured and has no leverage, we would be required to put up $5000, less the credit we receive for selling the put. Each put contract has the theoretical equivalent of 100 shares of long stock, which is why the shares are already accounted for when selling the put.
In a margin account, however, we would only be required to put up a fraction of the total value. In a lot of cases, it may be around 20% of the strike (around $1000 in this case). There are a few different calculations the brokerage works through, and they choose the highest value of those calculations for BPR. This is where leverage plays a role. We are only required to put up $1000 initially, but we still stand to lose $5000 less the credit received if the stock price goes to $0.00. This is why we always keep a lot of cash available in our portfolio, as these margin requirements can change by the minute.
Leverage is generally highest in futures products. Take /CL for example, which is the light sweet crude oil futures contract. This product trades for $1000 a point. That’s right, $1000 a point! If we own a futures contract, and /CL is up $1.00, we would see a gain of $1000. That means that in order to find the notional value, we’d have to multiply the current price by 1000. If /CL is trading at $47, the notional value of one contract is $47,000.
In a margin account, the cost to purchase one contract is only about $3,500 at that price! That means the investor is getting over 10:1 leverage on that contract, when you look at notional value vs buying power required to purchase the contract. All futures products are different, so it’s extremely important to understand the notional value & point value for futures contracts that you’re trading.
Leverage comes in all shapes and sizes. More leverage can give us a higher return on capital, as we’re not required to put up as much, but it can also magnify losses quickly. Understanding leverage and how we can use it is imperative for futures, options, and stock traders alike.
Market Data provided by CME Group & powered by dxFeed Technology. Options involve risk and are not suitable for all investors.
Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.
tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”). tastytrade is a trademark/servicemark owned by tastytrade.
Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.
Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information on this site should be considered general information and not in any case as a recommendation or advice concerning investment decisions. The reader itself is responsible for the risks associated with an investment decision based on the information stated in this material in light of his or her specific circumstances. The information on this website is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading in derivatives and other financial instruments involves risk, please read the Risk Disclosure Statement for Futures and Options. tastytrade is an investor in Small Exchange, Inc.