Understanding and Managing Leverage    • 173
matter if a significant chunk of your portfolio is exposed to those returns!
Lambda is a good measure to show how sensitive percentage returns are to 
a move in the stock price, but it is useless when trying to understand what 
the portfolio effects of those returns will be on an absolute basis.
Notional Exposure
Look back at the preceding table. Let’s say that we wanted to make 
lambda more useful in understanding portfolio effects by seeing how 
many contracts we would need to buy to match the absolute return of 
the underlying stock. Because our expected dollar return of one of the 
$39-strike calls only makes up about a third of the absolute return of the 
straight stock investment ($3.82 / $11.75 = 32.5% ≈ 1/3), it follows that if 
we wanted to make the same dollar return by investing in these call options 
that we expect to make by buying the shares, we would have to buy three 
of the call options for every share we wanted to buy. Recalling that op-
tions are transacted in contract sizes of 100 shares, we know that if we were 
willing to buy 100 shares of Oracle’s stock, we would have to buy options 
implying control over 300 shares to generate the same absolute profit for 
our portfolio.
I call this implied control figure notional exposure. Continuing with 
the $39-strike example, we can see that the measure of our leverage on the 
basis of notional exposure is 3:1. The value of the notional exposure is cal-
culated by multiplying it by the strike; in this case, the notional exposure 
of 300 shares multiplied by the strike price of $39 gives a notional value 
for the contracts of $11,700. This value is called the notional amount of the 
option position. 
Some people calculate a leverage figure by dividing the notional amount 
by the total cost of the options. In our example, we would pay $18 per con-
tract for three contracts, so leverage measured in this way would work out to 
be 217 (= $11,700 ÷ $54). I actually do not believe this last measure of lever-
age to be very helpful, but notional control will become important when we 
talk about the leverage of short-call spreads later in this chapter.
These simple methods of measuring leverage have their place in ana-
lyzing option investment strategies, but in order to really master leverage, 
you must understand leverage in the context of portfolio management.