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. 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 >>
  2. How is a put option exercised?

    A put option is a contract that gives the option holder the right, but not obligation, to sell a set amount of shares (1 ... Read Answer >>
  3. I've noticed executives buy a lot of stock below market value, and then they sell ...

    On October 30, 2006, a Google executive officer purchased 2,541 shares of Google at $9 per share and sold these same shares ... Read Answer >>
  4. How can derivatives be used to earn income?

    Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >>
Related Articles
  1. Personal Finance

    What Is A Pyramid Scheme?

    The FTC announced it had opened an official investigation of Herbalife, which has been accused of running a pyramid scheme. But what exactly does that mean?
  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. Small Business

    Multi-Level Marketing

    Learn how to differentiate between a legitimate marketing strategy and a pyramid scheme.
  4. 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
  5. Investing

    What Is A Pyramid Scheme?

    Find out how this financial scam works and why you should watch out.
  6. Financial Advisor

    The Best Strategies to Manage Your Stock Options

    We look at strategies to help manage taxes and the exercise of incentive and non-qualified stock options.
  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. Trading

    Dividends, Interest Rates And Their Effect On Stock Options

    Learn how analyzing these variables are crucial to knowing when to exercise early.
  9. Taxes

    Explaining Unrealized Gain

    An unrealized gain occurs when the current price of a security exceeds the price an investor paid for the security.
  10. Financial Advisor

    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.
RELATED TERMS
  1. Investment Pyramid

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

    A right to cancel an annuity or life insurance contract in exchange ...
  3. Aggregate Exercise Price

    The strike price of a put or call option multiplied by its contract ...
  4. Wedding Warrant

    A warrant that can only be exercised if the host asset, typically ...
  5. Exercise Backdating

    A practice where option holders fraudulently claim to have exercised ...
  6. Early Exercise

    The exercise of an option prior to its expiration date. Early ...
Hot Definitions
  1. Treasury Bill - T-Bill

    A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations ...
  2. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
  3. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure typically used by analysts to identify companies that generate ...
  4. Majority Shareholder

    A person or entity that owns more than 50% of a company's outstanding shares. The majority shareholder is often the founder ...
  5. Competitive Advantage

    An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers ...
  6. Mutual Fund

    An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities ...
Trading Center