Understanding and Managing Leverage    • 181
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(5,000)
-
15,000
10,000
20,000
25,000
30,000
5,000
Unrealized Gain
Unrealized Loss
Cash Value
Net Gain (Loss) - Levered
Realized Loss
Instrument Maximum-Loss Price Net Profit at Fair Value Estimate
Stock $0 $1,472
Option $22 (11 × stock loss) $4,833 (5.1 × stock profit)
The 11 times loss figure was calculated in the following way: there is a 
total of 47.3 percent of my allocation to this investment that is lost if the price 
of the stock goes down by 4.3 percent, so −47.3 percent/4.3 percent = −11.0. 
Obviously, this policy of keeping some cash in reserve represents a sensible ap-
proach to portfolio management when leverage is used. An investor in straight 
stock who makes 20 investments that do not hit his or her expected fair value 
within the investment horizon might have a few bad years of performance, but 
an investor who uses maximum option leverage and allocates 5 percent to 20 
ideas will end up bankrupt if these don’t work out by expiration time!
Similar to setting a cash reserve, you also might decide to make an 
investment that combines cash, stock, and options. For example, I might 
buy 100 shares of Intel, three ITM option contracts, and leave the rest of 
my 5 percent allocation in cash. Here is what that profit and loss profile 
would look like: