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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 the situation where we're buying the stock, we're clearly putting $50 up front. If the stock moved up to $80, and we able to perfectly call the top and sell it for that $80, we would make a $30 profit off of a $50 initial investment. That's a 60% gain. That's a 60% gain on our upfront capital. On the other side, if the stock were to go down to $20, we would loose $30 of our $50 upfront investment. 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%. In terms of the potential upside you can gain an unlimited amount. The stock can just really go to any possible value. In terms of loss when you buy a stock the most you can lose is 100%. Let's think about the scenario with the call option. With the call option. To buy the call option it only cost us $5. We only have to put $5 upfront. The scenario where the stock went up to $80, we figured out that we were able to profit $15 net of the price of the options. This was our pure profit. On a base of $5 investment we were able to get $15 of profit. 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. We essentially just lost all of the money of the option. We lost 100%. What I want to show here is that when an option did is it gave us leverage. It gave us leverage. 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. A call option is giving you financial leverage. You're essentially making this same bet here, but you're multiplying potential gain or your potential loss. If the stock you ... based on the scenario we painted in the good scenario you made 60%. But in the call option in the good scenario you made 300%. We multiplied. We multiplied our gain. On the downside with the stock we lost 60%. With the call option we lost 100%. Once again, we multiplied our loss. Right here it looks the numbers are still favorable, because our loss multiplication wasn't as much as our gain multiplication. This is really based on some of the numbers I chose. The important thing to realize is if you're dealing with 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.