Accepting Exposure   • 229
×= ≈$19,500
$5,000 13 .9 4: 1leverage
Selling the $195/$220 call spread will generate $651 worth of pre-
mium income and put at risk $2,500 worth of capital. Nothing can change 
these two numbers—in this sense, the short-call spread has no leverage. 
The 4:1 leverage figure merely means that the percentage  return will ap-
pear nearly four times as large on a given allocation as a 1:1 allocation 
would appear. The following table—assuming the sale of one contract of 
the $195/$220 call spread—shows this in detail:
Winning Case Losing Case
Premium 
Received 
($)
Target 
Allocation 
($) Leverage
Stock 
Move ($)
Percent 
Return on 
Allocation
Stock 
Move 
($)
Dollar 
Return
Percent 
Return on 
Allocation
651 20,000 1:1 –2 3.3 +25 –1,849 –9.2
651 10,000 2:1 –2 6.5 +25 –1,849 –18.5
651 5,000 4:1 –2 13.0 +25 –1,849 –37.0
Note: The dollar return in the losing case is calculated as the loss of the $2,500 of margin 
per contract less than the premium received of $651.
Notice that the premium received never changes, nor does the worst-
case return. Only the perception of the loss changes with the size of our 
target allocation.
Now that we have a sense of how to calculate what strategic leverage 
we are using, let’s think about how to size the position and about how much 
risk we are willing to take. When we are selling a call or call spread, we are 
committing to sell a stock at the strike price. If we were actually selling the 
stock at that price rather than committing to do so, where would we put 
our stop loss—in other words, when would we close the position, assuming 
that our valuation or our timing was not correct?
Let’s say that for this stock, if the price rose to $250, you would be 
willing to admit that you were wrong and would realize a loss of $55 per share, 
or $5,500 per hundred shares. This figure—the $5,500 per hundred shares 
you would be willing to lose in an unlevered short stock position—can be 
used as a guide to select the size of your levered short-call spread.