Chapter 8
Leverage and Call Options

In 2010, a trader made a bet that the S&P 500 would rise — not by buying index shares, but by buying long-term call options. His prediction was only partially correct. The market did rise — but not immediately. His calls expired, worthless.

In 2013, another trader made the same bet, but with a different approach. He bought call options that expired three years later. When the market climbed steadily over the next 24 months, his modest position turned into a multi-bagger — a small input, a big result.

That difference? Leverage done wisely.

Leverage is a double-edged sword. It can accelerate your growth — or amplify your mistakes. It can get you into a position that would otherwise be too expensive — or take you out of one faster than you expected.

In this chapter, we’re going to explore how to use call options to achieve leveraged exposure to SPY — thoughtfully, intentionally, and with full awareness of the trade-offs.

We’ll begin by breaking down what leverage really is — not just in the abstract, but how it affects your dollars, your decisions, and your risk. Then, we’ll explore how strike price and expiration influence leverage levels in options. You’ll see why buying long-term calls — often called LEAPS — gives you staying power that short-term trades can’t match.

This isn’t about maximizing risk. It’s about optimizing opportunity — and learning to control leverage instead of letting it control you.

8.1 What is leverage and how it magnifies returns

Leverage means doing more with less.

In trading, leverage allows you to control a larger position with a smaller amount of capital. When used correctly, it can magnify your gains. When used recklessly, it can accelerate your losses. But like any tool, its effectiveness depends on how — and when — you use it.

Let’s walk through a basic comparison using SPY, the ETF that tracks the S&P 500.

Example: Buying SPY Directly

Suppose SPY is trading at $500 per share. If you want to buy 100 shares, you’ll need:

If SPY rises by 10% to $550, your investment grows to $55,000. That’s a 10% return.

But you had to commit the full $50,000 to make it happen.

Example: Using Margin (Broker Leverage)

Suppose your broker offers a 2:1 margin at a 5.25% annual interest rate. You invest $25,000 of your own money and borrow another $25,000 to buy 100 shares of SPY at $500.

If SPY rises to $550 after 1 year:

You earned a higher percentage return than buying without leverage, but you also took on debt and interest costs. If SPY fell instead, your losses would be magnified, plus you’d still owe the interest.

Example: Using Call Options

Now let’s consider a third method: buying a long-term call option.

Suppose you buy a call option on SPY with a strike price of $300, expiring in 12 months. The option costs $210, or $21,000 per contract (since one contract controls 100 shares).

If SPY rises to $550 after 1 year:

Here, you’ve used far less capital compared to buying shares, taken no margin loan, and your risk is capped: the most you can lose is the $21,000 premium you paid.

However, option leverage is not free either. Even though deep in-the-money options minimize the time value cost, you still pay some premium above the intrinsic value — typically less than 5.25% for deep ITM SPY options.

Comparison: Direct Buy vs Margin vs Call Options

Conclusion: Each method provides a different way to achieve leverage. Buying shares directly offers simplicity but demands significant capital. Using margin amplifies both gains and losses, and introduces ongoing interest costs. Buying deep in-the-money call options provides built-in leverage with limited downside, and requires less capital, but you do pay a time value premium upfront. After purchasing, maintaining a call option position generally requires minimal effort. The best approach depends on your investment style, risk tolerance, and expectations for SPY’s future performance.

8.2 Risks associated with leverage

Leverage is a powerful tool — but power always comes with risk. While leverage can amplify your returns, it also magnifies your losses. When used carelessly, it doesn’t just speed up your gains — it accelerates your failure.

The math is simple: if a 10% move in the market gives you a 30% return, then a 10% move against you can wipe out 30% just as quickly.

Understanding the risks of leverage isn’t optional — it’s essential.

Margin: The Hidden Cost of Borrowing

When you use margin, you’re borrowing money from your broker to buy more stock than you could otherwise afford. This has two major consequences:

• Interest costs: You pay ongoing interest on the borrowed funds, which eats into your profits — especially over long periods.
• Liquidation risk: If your position drops too far in value, your broker may issue a margin call. If you can’t meet it quickly, they can forcibly liquidate your position at a loss, often during peak volatility.

Even if you’re right in the long run, margin can take you out of the trade before you’re proven correct.

Options: Defined Loss, Psychological Risk

Call options offer a cleaner form of leverage. You don’t borrow anything — you simply pay a premium upfront. That premium is your maximum risk.

There are no margin calls, no interest charges, and no risk of liquidation. If the trade goes against you, you can’t lose more than what you paid.

But options come with a different type of risk: certainty of expiration.

Every option has a fixed lifespan. If the stock doesn’t move in your favor before expiration, the option can expire worthless — even if your thesis was correct, just too early.

This creates a subtle but serious danger: the temptation to chase, double down, or keep buying shorter-term options in search of quick profits. Discipline is key.

Comparison of Leverage Risks

Why I Prefer Call Options Over Broker Margin for Leverage

When seeking leverage, I prefer using deep in-the-money (ITM) long-term call options (LEAPS) rather than borrowing on margin. There are two main reasons for this preference:

• Lower Cost of Leverage: For LEAPS deep ITM calls, the time value premium you pay is often much lower than the annual interest rate charged by brokers for margin borrowing. For example, if a broker charges 5% to 8% per year on margin, but the time value embedded in the LEAPS is only 2%-4%, call options provide cheaper leverage overall.
• No Margin Call Risk: Using margin means that a significant price drop can trigger a margin call, forcing you to deposit more funds or liquidate at a loss. With call options, your maximum loss is limited to the premium you paid upfront. There is no risk of forced selling or unexpected liquidation.

In short, deep ITM LEAPS provide a way to apply intelligent leverage — with lower costs and greater security compared to using broker margin.

The Right Kind of Leverage

Used wisely, options offer a unique kind of leverage: asymmetric, defined-risk exposure with no borrowing. But this does not mean they’re risk-free. It only means that the risks are different — and potentially more manageable.

In the next sections, we’ll explore how to control those risks by carefully selecting strike prices and expiration dates that align with your goals, your timeline, and your tolerance for uncertainty.

8.3 How Strike Price Determines Leverage Level

When you buy a call option, one of the most important decisions you make is choosing the strike price. For deep in-the-money (ITM) options, the strike price directly affects how much intrinsic value you control, how much time value you pay for, and how much leverage you are applying to your capital.

Let’s walk through what happens in practical terms.

Lower Strike = More Intrinsic Value = Lower Leverage

Suppose SPY is trading at $500. You buy a call option with a $200 strike price. This option is deep in the money, with:

Assuming a typical time value of about 2% of the stock price, you pay:

Since most of what you pay is intrinsic value, your leverage is low but your position is very stable.

Higher Strike (Still Deep ITM) = Less Intrinsic Value = More Leverage

Now instead, you buy a call option with a $300 strike price. This option has:

Assuming a slightly higher time value due to the higher strike:

This option is cheaper, giving you more leverage relative to your capital, but it is slightly more sensitive to time decay and stock price movements.

Profit and Loss Scenarios

Let’s now see how each position performs if SPY rises to $600 or falls to $400.

Scenario 1: SPY rises to $600

- For the $200 strike call:

- For the $300 strike call:

Scenario 2: SPY falls to $400

- For the $200 strike call:

- For the $300 strike call:

Summary Table

What This Means for Strategy

Lower strike deep ITM options provide lower leverage and more stable returns. They lose less in a downturn and gain steadily when the stock rises. Higher strike deep ITM options offer greater leverage and higher potential returns, but at the cost of steeper losses if the stock moves against you.

Choosing the right strike price is a balance between seeking higher returns and managing downside risks.

8.4 Understanding time value and expiration decay

Options don’t last forever. Every day that passes brings them closer to expiration — and that ticking clock erodes their value. This is known as time decay, and it’s one of the most important forces affecting option prices.

Time Value and Theta Decay

When you buy a call option, part of what you’re paying for is time value — the potential for the stock to move in your favor before expiration. This time value decreases as expiration approaches. The rate at which it declines is called theta.

The shorter the time until expiration, the faster the time value decays. This decay accelerates in the final weeks, which is why many short-term options lose value quickly, even if the stock doesn’t move much.

Why Long-Term Options Are Different

Long-term options — especially those with one to three years until expiration — decay much more slowly. They give the stock more time to move in your favor, and they retain more of their value if the price doesn’t change immediately.

This slower decay is why we prefer longer-dated options when using calls for leveraged exposure to SPY. You don’t want to bet on what SPY will do this week — you want to participate in broader trends that can take months or years to play out.

Introducing LEAPS

LEAPS, or Long-Term Equity Anticipation Securities, are call options with expiration dates more than one year into the future. They behave just like regular call options — but with more staying power.

Why We Use LEAPS in This Book

We aren’t here to gamble on short-term swings. We’re building strategies that can survive volatility and capture long-term trends in SPY — without the risk of being wiped out by time decay.

That’s why, in this book, we focus on buying call options with 1 to 3 years of time until expiration. It gives us the leverage we want, while keeping theta decay under control — and that’s the balance we need to test real, data-driven performance.

8.5 Using Long-Term Deep ITM Call Options

By now, you’ve seen how options offer leverage without borrowing, and how long-term calls (LEAPs) provide staying power without suffering rapid time decay.

In this section, we’ll lay out a clear and repeatable framework for using deep in-the-money (ITM) SPY call options to replace direct stock ownership — while applying intelligent, limited-risk leverage.

The Objective

Our goal is simple: gain exposure to SPY’s long-term upside with far less capital than buying shares outright, while avoiding the risks of margin borrowing.

By using long-term deep ITM calls, we achieve several important advantages:

• High Intrinsic Value: Most of the premium you pay is real, tangible value, not speculative time value.
• Minimal Time Decay: Deep ITM options typically have very low time premiums (often around 2% of SPY’s price), meaning they lose value slowly even if SPY moves sideways.
• Stock-Like Behavior: They move almost point-for-point with SPY, providing predictable exposure.
• Capped Risk, No Margin Calls: The maximum loss is the initial premium paid — with no risk of forced liquidation.
• Capital Efficiency: You control a large SPY-equivalent position with a much smaller cash outlay compared to buying shares directly.

This creates an asymmetric payoff: the downside is strictly limited, but the upside remains tied to SPY’s growth over time.

Choosing the Right Options

Throughout this book, we will focus on a specific class of options: long-term deep ITM LEAPs. These options have two defining characteristics:

• Expiration: 1 to 3 years remaining — providing enough time for SPY’s natural trends to play out while minimizing short-term time decay.
• Strike Price: Between 30% and 60% of SPY’s current market price — ensuring the option is deeply in the money, with most of its value intrinsic.

Choosing a deep ITM strike automatically results in stock-like behavior without the need to separately manage technical factors like delta.

Looking Ahead

Of course, theory is only useful if it holds up in practice. In the next sections, we will backtest this approach across decades of SPY history — testing different expiration lengths, strike prices, and comparing results against simply buying SPY directly. The goal is not just to explain why this method makes sense — but to prove how well it works over time.