Understanding and Managing Leverage    • 179
In this example, we suffer a realized loss of 96 percent (= $4,800 ÷ 
$5,000) if the stock falls 35 percent, so the equation becomes
= − =− ×Lossleverage 96%
35% 2.8
 
(By convention, I’ll always write the loss leverage as a negative.) This 
equation just means that it takes a drop of 35 percent to realize a loss on 
96 percent of the allocation.
The profit leverage is simply a ratio of the levered portfolio’s net profit 
to the unlevered portfolio’s net profit at the fair value estimate. For this 
example, we have
== ×Profitleverage $4,200
$1,472 3.0
 
Let’s do the same exercise for the ATM and OTM options and see 
what fully levered portfolios with each of these options would look like 
from a risk-return perspective. If we bought as many $22-strike options as 
a $5,000 position size would allow (19 contracts in all), our profit and loss 
graph and table would look like this:
02468 10 12 14 16 18 20 22 24
Stock Price
Levered Strategy Overview
Gain (Loss) on Allocation
26 28 30 32 34 36 38 40 42 44 46 48 50(20,000)
-
40,000
60,000
80,000
100,000
20,000
Unrealized Gain
Unrealized Loss
Cash Value
Net Gain (Loss) - Levered
Realized Loss