Hello I have a question if anyone can help. What does "gearing" mean with respect to derivatives. In CT2 we learned that gearing is the level of borrowing in a company. However, I'm sure there is a different meaning here. In Chapter 22 (Portfolio Management 3) it says: (i) An investment manager ..... can use the highly geared nature of futures to enhance returns (ii) ..... buying calls gives a high level of gearing and low dealing costs. Can anyone explain? Cheers
gearing When a company has a lot of gearing its equity shares are very exposed to changes in profitability (because there is a big fixed charge in the profit and loss). The same concept is referred to loosely as being "geared" to something. When you buy a future you place only a small amount of money in a margin account, but you have a huge exposure to the underlying asset. Hence futures offer a geared exposure to the underlying asset. Likewise options require only a small investment but give a large exposure to the underlying. This all relates loosely to the concept of a highly geared company. Hope this helps
