I am trying to calculate the total leverage inherent in a long/short equity hedge fund trading options, futures and swaps. For a fund, how do I calculate the leverage of an option. I think I will need to specify the leverage in terms of a specific change in the underlying. EG what is the leverage of the portfolio, if everything rises by 10% or falls by 10%. I dont think its possible just to specify the inherent leverage of a hedge fund without stating a shift in the underlying. Is this correct??

Leverage is possibly one of the most useless measures of risk that hedge fund investors harp on about. There is no one definition and when you are dealing with a portfolio of positions in equities, fi and fx it is pretty hard to come up with a measure of leverage that is satisfactory.Lets look at your specific case. Your portfolio is a long/short stock position possibly with a few options. Lets say you have $100mm under management and the gross value of your longs is $300mm and the gross value of your short positions is $200mm. On a gross basis you are 5x leveraged. On a net basis your leverage is 1x. Which of the two measures is correct ? I dont know but I would warrant that neither gives you an idea of how much risk you have. To net the position I have assumed a correlation of 1. In reality the correlation is going to be less than that. So your true leverage is somewhere between 1 and 5.If you have options in your portfolio then use the otpions delta to calculate an equivalent position in the underlying and then add that to your gross position.As you can probably I guess I am not a big fan of leverage as a measure of risk in a portfolio. I am more in favour of using a VaR approach (with all its shortcomings) as a risk measure than leverage.My 2cents worth.

I completely agree that leverage is a useless measure unfortunately it is widely used...I would argue that you should look at it on a gross basis, because even if correlation is 1 (say you have a reversal on), by entering in the trade you effectively create additional leverage on your capital as you are a net receiver of cash, and this is similar to increasing the leverage you get from your prime broker. I think this problem is much more significant than the variation of the leverage under certain portfolio scenarios.RgdsK