A Better Way to Double Your Returns

Lately, everyone seems to be in a hurry to earn back the money they lost last year as quickly as possible. That's created a perfect environment for companies offering leveraged exchange-traded funds, which promise amplified returns from market movements in either direction.

But if you're looking for the kind of leverage that lets you truly multiply your long-term returns, then those ETFs aren't the way to go. Instead, there's a better strategy involving options. It'll give you at least a chance of making some serious money, if you pick the right stocks.

Why leveraged ETFs didn't work
The reason leveraged ETFs have gotten so much attention lately, from warnings from financial regulators to outright bans at some brokers, is that they don't work when you hold them over multiple trading sessions. Typically, these ETFs are designed to track indexes on a daily basis. 

The problem, though, is that they don't track those same indexes for longer periods of time. As a result, sometimes both the bullish and bearish ETFs tied to the same index produce substantial losses for ETF shareholders. Just take a look at some examples:

Source: Yahoo! Finance as of Dec. 3.

You'd think that either bulls or bears would've made money. Yet with these ETFs, it didn't matter which way you bet -- if you held onto these funds all year, you lost money.

Know your investment
If you want leverage for a longer period than a single day, you need to pick an investment that's better-suited to that purpose. One way would be to buy stock on margin, but that has its own dangers. However, there's an alternative using options that's quite a bit safer.

Say you want to use double leverage over a period of several months. One easy method to get that leverage is to buy deep in-the-money call options that cost about half what you'd pay for the company's stock. If you do that, you can buy options on 200 shares with the same money you'd pay for 100 shares outright. That doubles your risk -- and reward.

Here are some examples of how this options strategy can work in real life:

Source: CBOE.
Options expire in 2010 unless otherwise noted, and prices are based on bid-ask spreads as of Dec. 7.

For more detail, look at General Electric. To buy 100 shares, you'd spend $1,620. Or you could buy call options on 200 shares for $1,540. If you bought the stock and it rose to $25 by mid-March, your shares would be worth $2,500, for a profit of $880. On the other hand, the options would be worth $17 per share, or $3,400, for a profit of $1,860 -- almost twice the profit from buying the stock, just as you intended.

Of course, if the stock price falls, you'll lose twice as much money. But that's the downside of using leverage.

Moreover, because options let you choose different expiration dates, you get to decide the length of time you want to measure your returns. Unlike leveraged ETFs, you're not stuck with the one-day timeframe. Now, because options have time value, you may have to pay extra for longer-dated options, but once you do, you never have to worry about the tracking errors that leveraged ETFs face.

Leverage is optional
Options open a number of interesting doors for investors, but not all of them involve any leverage whatsoever. Used wisely, they can be valuable tools to help you enhance your returns to generate extra income and attain better buying and selling prices -- just to name a couple.

In fact, Motley Fool CFO Ollen Douglass recently made more than $100,000 with a simple options strategy involving six well-known stocks, and he's looking to our Motley Fool Options service for real-money advice on what to do with his profits. To learn more about Ollen's story and find out more about options, just enter your email address in the box below to get the latest information.