Understanding and Managing Leverage    • 167
In two years, you are obligated to pay your counterparty $65 if you 
want to hold the stock, but the decision as to whether to take possession 
of the stock in return for payment is solely at your discretion. In essence, 
then, you can look at buying a call option as a conditional borrowing of 
funds sometime in the future. Buying the call option, you are saying, “I 
may want to borrow $65 two years from now. I will pay you some interest 
up front now, and if I decide to borrow the $65 in two years, I’ll pay you 
that principal then. ”
In graphic terms, we can think about this transaction like this:
5/18/2012 5/20/2013 249 499 749 999
-
10
20
30
40
50
60
70
80
90
$1.50 “prepaid interest”
Contingent loan, the future repayment
of principal is made solely at the
investor’s own discretion.
Fair Value Estimate
Advanced Building Corp. (ABC)
Date/Day Count
Stock Price
GREEN
If the stock does indeed hit the $85 mark just at the time our option 
expires, we will have realized a gross profit of $20 (=  $85 −  $65) on an 
investment of $1.50, for a percentage return of 1,233 percent! Obviously, 
the call option works very much like a loan in terms of altering the 
investor’s capital at risk and boosting subsequent investment returns. 
However, although the leverage looks very similar, there are two impor -
tant differences: