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Current time:0:00Total duration:3:04

Video transcript

if we were to buy the stock for $50 so this is a situation where we're buying the stock we're clearly putting $50 up front and if the stock moved up to $1 and we were able to perfectly call the top and sell it for that $80 we would make a $30 profit off of a $50 initial investment so that's a 60% gain that's a 60% gain on our upfront capital now on the other side if the stock were to go down to $20 we would lose $30 bit of our $50 upfront investment so it would be a 60% loss so in the buying the stock based on the scenario that I painted we could gain 60% or we could lose 60% and in terms of the potential upside you can gain an unlimited amount because the stock can just really go to any possible value and in terms of loss when you buy a stock the most you can lose is a hundred percent now let's think about the scenario with the call option call with the call option to buy the call option it only cost us $5 so we only had to put $5.00 up front and in the scenario where where the stock went up to $80 we figured out that we were able to profit $15 net of the price of the option so this was our pure profit so bait on a base of a $5 investment we were able to get $15 of profit so we were able to get a 300% gain we were able to get a 300% gain on the other side though if the stock went down we had no reason to actually exercise our option so we essentially just lost all of the money of the option so we lost 100 we lost 100% and what I want to show here is that what an option did is it gave us leverage it gave us leverage and the term comes from physics because a lever will give you kind of mechanical leverage it can allow you to exert more force than you otherwise could by using that simple tool and a call option is giving you financial leverage you're essentially making the same bet here but you're multiplying your potential gain or your potential loss if the stock you've been based on the scenario we've painted in the good scenario you made sixty percent but in the call option in the good scenario you made three hundred percent we multiplied multiplied our gain but on the downside with the stock we lost sixty percent but with the call option we lost 100% so once again we multiplied our loss and right here it looks like the numbers are still favorable because our our loss multiplication wasn't as much as our gain multiplication but this is really based on some of the numbers I chose but the important thing to realize is if you're dealing with an option to essentially make the same bet that the bet that the company will go up you're just putting leverage on your bet you're multiplying your potential gains or losses