A:

Pyramiding is a method of increasing margin by using unrealized returns from successful trades. Pyramiding works by surrendering a minimal amount of previously-owned shares in order to pay a part of the exercise price. The surrendered funds are used to purchase a larger amount of option shares. These shares are then surrendered back to the company so that the process repeats itself - with more funds added each time the action is completed - until the full option price is paid. Thus, the "optionee" is left only with an amount of shares equal to the option spread. The process of surrendering shares to pay some of the exercise price and then buying an increasingly larger number of option shares - with more funds added at each round - explains the trading method known as "pyramiding".

Pyramiding uses leverage to gain a larger position size and, along with other speculative practices, can be risky and potentially can lead to magnified gains or losses. While some hedge funds and private investors employ this method, many do not have the ability to set up such trades. In addition, most hedge funds avoid taking this type of large risk within a single position.

For more on this topic, read Triple Screen Trading System.

This question was answered by Richard C. Wilson.

RELATED FAQS
  1. What is a risk pyramid and why is it important?

    Learn about the risk pyramid and what it is used for; discover why it is important for investors to use the risk pyramid ... Read Answer >>
  2. What is the difference between a Ponzi and a pyramid scheme?

    Pyramid schemes and Ponzi schemes share many similar characteristics in which unsuspecting individuals are fooled by unscrupulous ... Read Answer >>
Related Articles
  1. Insurance

    Understanding Cash Surrender Value

    The amount of money an insurance company pays the owner of an insurance policy if the policy is voluntarily surrendered prior to the event that is insured
  2. Investing

    Determining Risk And The Risk Pyramid

    Many investors do not understand how to determine the risk level their individual portfolios should bear.
  3. Personal Finance

    What is a Pyramid Scheme?

    What exactly is a pyramid scheme? Read on.
  4. Small Business

    Multi-Level Marketing

    Learn how to differentiate between a legitimate marketing strategy and a pyramid scheme.
  5. Financial Advisor

    Cash Value vs. Surrender Value: What Is the Difference?

    How much you actually receive from the cash value of your life insurance policy is based on the surrender value, which can sometimes be much lower.
  6. Investing

    What Is A Pyramid Scheme?

    Find out how this financial scam works and why you should watch out.
  7. Trading

    4 Reasons To Hold Onto An Option

    There are times when an investor shouldn't exercise an option. Find out when to hold and when to fold.
  8. Taxes

    Explaining Unrealized Gain

    An unrealized gain occurs when the current price of a security exceeds the price an investor paid for the security.
  9. Retirement

    Taking The Bite Out Of Annuity Losses

    If this investment product has caused you sleepless nights, it's time to consider alternatives.
  10. Trading

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
RELATED TERMS
  1. Investment Pyramid

    A portfolio strategy that allocates assets according to the relative ...
  2. Surrender Period

    The amount of time an investor must wait until he or she can ...
  3. Surrender Rights

    A right to cancel an annuity or life insurance contract in exchange ...
  4. Surrender Fee

    A charge levied against an investor for the early withdrawal ...
  5. Surrender Charge

    A fee levied on a life insurance policyholder upon cancellation ...
  6. Wedding Warrant

    A warrant that can only be exercised if the host asset, typically ...
Hot Definitions
  1. Payback Period

    The length of time required to recover the cost of an investment. The payback period of a given investment or project is ...
  2. Collateral Value

    The estimated fair market value of an asset that is being used as loan collateral. Collateral value is determined by appraisal ...
  3. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  4. Current Account

    The difference between a nation’s savings and its investment. The current account is defined as the sum of goods and services ...
  5. Liability

    Liabilities are defined as a company's legal debts or obligations that arise during the course of business operations.
  6. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
Trading Center