Options example, what's the profit, 5% or 50% or zero?

[Aquarians]

Ok so if you use 1 dollar and make 2 then that instead is your denominator and numerator.

We're starting to reach an agreement here, more or less we speak the same Latin so far: https://www.elitetrader.com/et/thre...ciation-around-the-world.371844/#post-5743649

What I'm arguing about is whether that denominator is really $1 or actually zero. 100% return isn't bad, but can't compete with infinity, right?

 

[SoyUnGanador]

Simple % diff math:-

Account value is X before trade is initiated.

Account value is X + Y after trade is completed.

X + Y / X = percentage difference (gain/Loss)

Lol wat

 

[taowave]

Dont give up,you are soooo close

Simple % diff math:-

Account value is X before trade is initiated.

Account value is X + Y after trade is completed.

X + Y / X = percentage difference (gain/Loss)

 

[SunTrader]

Dont give up,you are soooo close

CEFGW

 

[taowave]

Keep it simple,you have 100 bucks in your account..You made 5 bucks..

Yeah,you can look at levered returns and/returns on margin,but that's just smoke and mirrors.

if you are running money,including your own, what did you bank on your trading capital.That is the real question.No one asks what's you return on margin/leverage first.Thats for the smart guys to ask assuming the returns pass the sniff test

See LTCM

CEFGW

Consider the following theoretical example:
- stock price is around $100
- market price of put option on the stock is $10
- the true value of the put option is $15, so you consistently buy the option, delta-hedge using the stock and come out with an average profit of $5.

Let's say these are yearly options so we don't have to think about annualizing the PNL and all.

Question is, what is your return?

a) 50% per year since you make $5 on every $10 invested to buy the option.
b) Since you need to delta-hedge, you need to buy the stock in variable quantities but overall you need $100 to buy stock with them. So you make $5 on approximately $100, therefore your return on capital is just 5%.
c) $10 is your own money and $100 are borrowed money (from the bank or broker). Since this is a safe bet (arbitrage) you are sure to come out ahead by $5, so you borrow the $100, use them for a year, make $5 and return them to the bank (with interest). If interest rate were 0 (as it used to be), you'd be making 50% per year. But nowadays at 5% interest you're barely breaking even.

 

[Global OptionsTrades]

Quick answer is the net P&L for the whole trade divided by the Value at Risk.

But given the emphasis on hedging in the example, if you believe that markets are efficient and can hedge the position perfectly, any profit from the long put will be equal to the loss on stock, so the successful trade would provide zero profit whatever metric is chosen as a denominator.