ROE (Return on Equity) is determined by the unrealized profit and loss (PnL) of a position divided by the initial margin of the position.
When adjusting leverage for a position, the initial margin requirements change while the position size (quantity) remains constant.
Increasing leverage decreases the initial margin required, while decreasing leverage increases the initial margin required. Consequently, if the unrealized PnL remains constant, an increase in the initial margin reduces ROE, whereas a decrease in the initial margin increases ROE, despite the unchanged unrealized PnL.
Let’s see the example below,
Position size: 1 ETH on ETH/USDT USDT-M
Direction: Long
Leverage use: 5x
Average entry price: 3000
Current last traded Price: 3500
initial margin: 3000 / 5=600
Unrealized P&L of position (excluding fees): 1x1x3500-1x1x3000=500
ROE: 500/600=83.3%
Now assuming the leverage use is increased to 10x
New initial margin: 3000/10=300
ROE: 500/300=166.7%
In the above example, despite implementing higher leverage, the only variable that changed was the position margin (denominator), resulting in an increased ROE (from 83.3% to 166.7%). Nonetheless, the unrealized PnL remained consistent; if the trader decides to close the position, the profit and loss will be the same, regardless of whether they employ 10x or 20x leverage.
