In simple terms, leverage revolves around doing more with less. In finance, it refers to the ability of an investor to control monetary amounts of a commodity or security larger than the amount of capital available. This involves the multiplied effect on profit and loss or position value that results from using borrowed funds. More specifically, It is the augmenting effect on the equity capital invested by borrowing at rates relatively close to the risk-free rate. Differently stated, this refers to the amount of risk that corresponds to one unit of equity capital. It occurs when an instrument rises or falls at a proportionally higher pace than a comparable or underlying instrument.

Typically, derivatives are characterized by the leverage property (i.e., the possibility of powerful leverage) that gives them one advantage over other types of instruments such as stocks and bonds but at higher volatility. Literally, leverage in derivatives is dubbed “notional leverage”. The high leverage of derivatives can result in greater profits, but that comes with the cost of increased risk, which may be translated, if things don’t go well, into greater losses. Leverage in derivatives mainly come from three sources: futures leverage, option leverage, and swap leverage.