What are the Different Types of Leveraged Investments?

Justin Riche

Vehicles such as futures, options and exchange traded funds (ETFs), offer leveraged investments. Through these vehicles, individuals and institutions alike can practically invest in all asset classes, such as equities, bonds, foreign currencies, agricultural commodities, metals, energy commodities and more. Moreover, leveraged investments allow investors to multiply gains, although they can equally multiply losses if the markets go against them.

Leveraged investments allow investors to multiply gains.
Leveraged investments allow investors to multiply gains.

Many leveraged investments enable investors to control more assets with a small amount of money, which is usually called margin trading. The margin is the initial money deposited into a trading account, which will be leveraged to buy or sell assets whose cash value is greater than the deposited amount. Some investors use collateralized margin loans, meaning that if the securities purchased with the borrowed money significantly lose value, the investors can incur debts. If they cannot settle these debts, personal assets might be seized.

Futures, options and exchange traded funds (ETFs) all offer leveraged investments.
Futures, options and exchange traded funds (ETFs) all offer leveraged investments.

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Leveraged investments such as futures are traded through contracts, which are agreements between buyers and sellers to exchange a particular asset at a specified date in the future. The futures contract is binding, meaning that the asset will be delivered at that specific date, moreover, the asset in question can belong to just about any class. Investors, however, can still trade this contract without the actual assets being delivered to them. They do this normally by cashing in before the delivery date. Futures trading typically allows leverage of up to 10:1, which means, for instance, an investor with $5,000 US Dollars (USD) can control assets worth $50,000 USD, and this would potentially magnify his or her profits or losses.

Options are leveraged investments that give traders the right but not the obligation to buy or sell a particular asset at a specified price on or before a certain date in the future. The cost of buying an option is called a premium. For example, with a $5 USD premium, one can get an option to buy or sell an asset at $75 USD within a specific time frame. If the investor had bought the option to buy, and if the asset's value had subsequently risen to or above $85 USD before the expiration date, he or she would have the option to exercise the contract. He or she can buy the asset at $75 USD then choose to quickly sell it at $85 USD or more and pocket the difference.

There are even ETF options, which permit investors to use the same options strategies on these instruments. ETFs are generally designed to track particular market indices and are backed by a portfolio of the assets they represent. These assets can be, for example, commodities such as gold, crude oil and such. This ETF in turn will allow investors to trade it just like a normal stock, and thus gain exposure to the particular assets that comprise it. There are ETFs with double or even triple leverage, meaning that for every 20 percent increase in the assets they represent, the ETF will rise 40 or 60 percent, respectively.

There also is spot foreign exchange, also referred to as spot forex, which involves trading currencies to make profits from the fluctuations in the forex market. Leverage in the United States, by regulation, is usually up to 50:1, and in some countries, brokers offer leverage of up to 500:1. This means that an investor can control $50 USD worth of currencies or as much as $500 USD with only $1 USD. Furthermore, modern finance offers many more leveraged investments, and thus the leverage-hunting investor should stay up to date with new developments in the field, because financiers often invent new leveraged instruments.

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