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 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 >>
  2. If I surrender this life insurance policy and take the $40,000, are there any tax ...

    I have a flex life policy for $100,000 that has a cash value or surrender value of $40,000. ... Read Answer >>
  3. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
  4. Would I owe taxes on a 1035 exchange?

    I have an old paid-up life policy with a substantial outstanding loan. If I surrender the policy, the ... Read Answer >>
  5. How do hedge funds use equity options?

    Learn about two of the most common equity option strategies hedge fund managers use every day to generate above-average returns ... Read Answer >>
  6. How do hedge funds use leverage?

    Learn how hedge funds use leverage techniques such as margin, credit lines and financial derivatives to increase return on ... Read Answer >>
Related Articles
  1. Active Trading Fundamentals

    Pyramid Your Way To Profits

    This strategy involves scaling into profitable investments as they continue to rise.
  2. Entrepreneurship

    Multi-Level Marketing

    Learn how to differentiate between a legitimate marketing strategy and a pyramid scheme.
  3. Options & Futures

    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.
  4. Stock Analysis

    How To Profit From My Early Call To Short This Overvalued Stock

    It's difficult to admit that I was too early with a market call. It's even harder to accept when I realize I was riding the coattails of a billion-dollar bet made by a renowned activist ...
  5. Options & Futures

    Options Hazards That Can Bruise Your Portfolio

    Learn the top three risks and how they can affect you on either side of an options trade.
  6. Options & Futures

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
  7. Options & Futures

    Introduction - Day Trading and Options

    Options have not been a tradition part of day-trading strategy, but this is quickly changing.
  8. Products and Investments

    Here's How to Duck a FINRA Slap on L Shares

    Regular and L-share annuity contracts come with back-end surrender charges that clients should know. Here's how to steer clear of any compliance trouble.
  9. Personal Finance

    Recognize And Avoid "Work At Home" Scams

    From pyramid schemes to envelope stuffing, there are a lot of scams masquerading as legitimate part-time work.
  10. Options & Futures

    Understanding Bull Spread Option Strategies

    Bull spread option strategies, such as a bull call spread strategy, are hedging strategies for traders to take a bullish view while reducing risk.
RELATED TERMS
  1. Pyramiding

    A method of increasing a position size by using unrealized profits ...
  2. Investment Pyramid

    A portfolio strategy that allocates assets according to the relative ...
  3. Pyramid Scheme

    An illegal investment scam based on a hierarchical setup. New ...
  4. Surrender Period

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

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

    A charge levied against an investor for the early withdrawal ...
Hot Definitions
  1. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  2. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  3. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  4. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  5. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  6. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
Trading Center