Experienced traders who want to increase their returns often
use leverage. This enables them to use small amounts of cash to control a large
amount of assets. However, leverage has its dangers too and one would be well
advised to understand what those dangers are before actively participating in
instruments which employ leverage.



Futures traders do it. They post a small amount of margin and move 5000 oz. of
silver or 1000 barrels of oil. FX traders do it. Most FX shops offer 100:1
leverage on large accounts or even 200:1 on smaller accounts. Options traders do
it too. Or at least binary options traders. When they buy a binary for $2 and
sell minutes later for $8, while the underlying asset barely moved, they use
leverage.



Let us look at three leveraging alternatives: futures, spot FX and binaries. In
each we put up some cash upfront in the form of a margin or an option premium,
and then we speculate on the movement in the price of the underlying asset.
Leverage magnifies the impact of the price movements on our profit and loss, so
that a small movement in the underlying price causes a large change to our cash
position.



Futures and FX



When trading futures, we are required to post an initial margin and stay above a
maintenance margin as specified by the exchange. For example, as of September
20, 2006, NYMEX non-member traders were subject to the following margin
requirements:







If you deposited $5,400 in the margin account to buy 1 futures contract on
silver, your money controlled 5000 oz. of silver or a total value of $55,000. If
silver went up by $1, you gained $5000, and your cash position increased to
$10,400. For a $1/11.50 or 8.7% increase in silver price, your profit was
5000/5400 or 92.6%.



When trading spot FX, we post a 1% (100:1) or 0.5% (200:1) margin. If, when the
USD/EUR rate is 1.2700, you deposit $1270 into your margin account to buy
euros/sell dollars, you control â"