Leverage & Payoff
Leverage & Payoff​
Leverage is one of the most important aspects of futures trading. It allows traders to control a large position with a relatively small amount of capital, amplifying both potential profits and risks. For AlgoTest users, understanding leverage is critical for building effective strategies in our Strategy Builder and testing them in the Simulator with historical data.
What is Leverage?​
Leverage enables you to take a larger position in the market than your available capital would normally allow. It works by requiring only a fraction of the total contract value, called margin, to initiate a futures trade. While this can greatly magnify profits, it also exposes you to higher risks since even small changes in the underlying asset’s price can have a significant impact on your position.
Example: Real Estate Leverage​
Let’s take an example from real estate to understand leverage better. Suppose you buy a property worth ₹1 crore, but you only need to pay 10% upfront, i.e., ₹10 lakh. A year later, if the property’s value rises to ₹1.25 crore, your profit would be ₹25 lakh. That’s a 250% return on your initial investment of ₹10 lakh, not the property’s full value. This is how leverage multiplies returns with a smaller cash outlay.
How Leverage Works in Futures Trading​
In futures trading, leverage works similarly. Let’s say you want to trade TCS futures. The contract value is ₹2,95,250 (for 125 shares at ₹2,362 per share). Instead of paying the full amount, you only need to pay the margin, which is typically around 14% of the contract value. In this case, the margin would be ₹41,335.
Now, if the price of TCS rises to ₹2,519 per share, the contract’s value increases to ₹3,14,875, generating a profit of ₹19,625 (the difference between ₹3,14,875 and ₹2,95,250). This profit is a 47% return on the margin you paid (₹41,335), even though the stock price only increased by about 6.6%.
Here’s a simple chart illustrating this:
| Leverage (Contract Value) | Price Change | Profit |
|---|---|---|
| â‚ą2,95,250 | +â‚ą157 | â‚ą19,625 |
| â‚ą2,95,250 | -â‚ą157 | -â‚ą19,625 |
Risks of Leverage ​
Leverage can be a double-edged sword. If the price moves against your position, you could incur significant losses. In our TCS example, if the stock price had dropped by â‚ą157 per share, you would have lost â‚ą19,625, which is nearly half of your margin.
Managing risk is essential when using leverage. AlgoTest’s Strategy Builder allows you to create strategies with built-in risk management tools like stop losses, while the Simulator lets you test how your leveraged positions would perform under real market conditions using historical data.
Futures Payoff​
The payoff from a futures trade is linear. If you’re long on TCS futures and the price rises, you profit for every upward movement. If the price falls, you lose the same amount per downward movement. This direct proportionality makes futures a “linear payoff” instrument.
Understanding how to use leverage responsibly can help AlgoTest traders maximise their gains while mitigating potential losses in volatile markets.