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Quote from falcon:

Mark,

I'm new to options and feeling confused over returns being quoted...

Any responses to clarify would be greatly appreciated.
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When selling premium, as in trading iron condors, the results depend on what happens during the month.

If the market is calm and the options quietly expire worthless, you can earn all the premium sold.

At other times, you may make some adjustments and retain only a portion of the original cash you collected.

At other times you lose - perhaps a little, perhaps a large amount. This is the most important category of all. If you can avoid large losses you will win over the longer term.

To avoid those big losses you need one skill - divided into two parts: Good money management; good risk management. As a beginner there is no chance whatsoever that you have these skills - unless you are a very experienced stock trader.

Your job is to understand how options work, learn to use the Greeks to measure risk (if you measure, or quantify risk, you will be able to understand how to reduce risk when necessary). It takes practice and paper trading is a reasonable way to go. Alternative: use real money with one or two lot positions.

If you have an account with 100,000, if you earn $2,000 per month, that's a 2% return on your money. Don't get caught in the trap of measuring return on money at risk - when dealing with iron condors.

If you have this cash available to trade, and you use only a small portion of it, then the remained earns nothing. Thus, base returns, as already suggested, on the size of your trading account.

What can you expect to earn? When you sell far out of the money call and put spreads, you can expect to make the entire premium almost all of the time. But this is a very bad idea. One loss will wipe out years of profits.

You want to sell out of the money spreads. You want to collect as much cash as possible, yet you don't want the probability of taking a loss to be too high. Some suggest selling index options with a delta of 7-8 (and then buying the next OTM option) to complete the spread.

I am more comfortable selling options with 15 delta. I also prefer 2 and 3-month positions, when most traders prefer to trade the front-month.

Each of these approaches collects a different amount of cash. Thus, the returns can vary wildly.

To begin, I'd try to earn 2% per month. That means selling about 2,500 to 3,000 worth of premium with a 100,000 account.
That is trading very small. But, it's good enough to get started.

If your account is only $5,000, then don't think in terms of dollars earned. $100 may not seem like much but it is 2%.

Commissions matter, so you need a deep discount broker.

You will discover that you must sell more than the amount you want to earn becasue you will not earn the full premium very often.

Good luck

Mark
http://blog.mdwoptions.com
 
I completely agree with measuring return on investment with the denominator being the net value of the account. You're so correct in pointing out the danger of measuring return based on either risk, or on a trade by trade basis.

Great posting immediately above.

4Q
 
Mark,

I have been reading your blog & am picking up many useful bits of information. Thanks.


If you have an account with 100,000, if you earn $2,000 per month, that's a 2% return on your money. Don't get caught in the trap of measuring return on money at risk - when dealing with iron condors.

Why not?

To begin, I'd try to earn 2% per month. That means selling about 2,500 to 3,000 worth of premium with a 100,000 account.
That is trading very small. But, it's good enough to get started.

Does that mean you would leave 90,000 in the account to do nothing and only sell 10 ICs? I have learnt from you blog that risk management is very important so I would closely manage and out positions early for profits or losses, so why not 30, 40 or 50 ICs per month?

Falcon
 
Quote from falcon:

Mark,

I have been reading your blog & am picking up many useful bits of information. Thanks.


If you have an account with 100,000, if you earn $2,000 per month, that's a 2% return on your money. Don't get caught in the trap of measuring return on money at risk - when dealing with iron condors.

Why not?

To begin, I'd try to earn 2% per month. That means selling about 2,500 to 3,000 worth of premium with a 100,000 account.
That is trading very small. But, it's good enough to get started.

Does that mean you would leave 90,000 in the account to do nothing and only sell 10 ICs? I have learnt from you blog that risk management is very important so I would closely manage and out positions early for profits or losses, so why not 30, 40 or 50 ICs per month?

Falcon
More...

Hi Falcon,

1) If you trade 10 iron condors with a margin requirement of $10,000 (it's less due to premium collected) and earn $2,000, it may be tempting to say that you made '20% on your investment.'

2) I don't think that's reasonable. Your goal as an investor is to earn a reasonable (to you) return, with reasonable risk, on your account. If you convince yourself that you made 20% per month for several consecutive months, and then post it on ET, no one is going to believe you.

Nor will your account have doubled - as it would with 20% returns for a few months.

3) You have money to invest. If YOU DECIDE to trade only 10 iron condors, that is your decision. You have money to invest and decided to remain in cash - or use the money for something else.

Those are investment decisions and your return for remaining in cash is almost zero these days. It's unreasonable IMO to pretend you earned a 20% return when your decision was: do nothing with the money.

4) Certainly 30 to 50 IC is reasonable for a 100k account. Especially when you own some additional insurance.

And some would trade 80 IC, leaving 20k in cash to allow room to make adjustments.

I hope you agree that the percentage of money put to use IS an investment decision. And if the choice is cash, the ROI for that cash is going to be zero. And the average ROI for the entire account is going to be pretty small.

5) That's what I believe gives you a realistic ROI.

But, it's just bookkeeping. If you prefer to keep your records differently, that's up to you. I believe keeping records is important, but I would never spend a great deal of time worrying over the details. Keep records so you have the information you need from those records.

If it gives a trader confidence to believe the ROI is 20% when it's 2%, so be it.

6) My recommendation for investing in only 10 iron condos was for someone who is just getting started and is in the learning process. Or for someone who trades a bunch of different strategies each month. After all, many investors have most of their money in stock, rather than in option positions.

Mark
 
Hi Mark,

I must be missing something as I have always interpreted ROI as precisely that, how much one can make on what is at risk. Which would mean 10,000 at risk generating 2,000 would be 20%. So I can't see how reasoning or confidence can come into it, it is what it is. :confused:

I do however understand what you are saying about the ROI for the overall account and it's importance however I can't seem to figure out why 5 -10% per month was deemed unrealistic when in fact on a 10,000 position earning lets say even less than 2,000 (make it 1,000) then having 50 ICs on would potentially give you 5,000, which equates to 5% on risk margin added to the remaining 50,000 in your account doing nothing would be 5% on the overall account.

Seems reasonable and realistic enough. What am missing here?

Thanks,

Falcon
 
My comment on the ROI is that the return that counts is the overall return on the total capital in the account.

Many of my individual spreads either gain 60% or something like that or lose 50% or so. Individually, in isolation, some of them may sound wonderful or horrible depending on which one you choose to highlight. However, the thing that is important is not those individual successes or disasters, but the overall context. Are we gaining in terms of total account dollars, or are we losing?

As far as IC's are concerned, my own recommendation is not to engage the entire account with them. I always keep some powder dry for adjustments, and other strategies which may be complementary. This reduces the overall possible rate of return, but makes the position safer, giving the necessary flexibility to practice wise money management.

The critical thing is to avoid serious losses at all times. It is far better to make 2% on average than to make 10% per month for 11 months and then lose 90% of the account in the last month.
 
Quote from falcon:

Hi Mark,

I must be missing something as I have always interpreted ROI as precisely that, how much one can make on what is at risk. Which would mean 10,000 at risk generating 2,000 would be 20%. So I can't see how reasoning or confidence can come into it, it is what it is. :confused:

I do however understand what you are saying about the ROI for the overall account and it's importance however I can't seem to figure out why 5 -10% per month was deemed unrealistic when in fact on a 10,000 position earning lets say even less than 2,000 (make it 1,000) then having 50 ICs on would potentially give you 5,000, which equates to 5% on risk margin added to the remaining 50,000 in your account doing nothing would be 5% on the overall account.

Seems reasonable and realistic enough. What am missing here?

Thanks,

Falcon
More...

ROI is precisely that: 'return on investment', not 'return on risk'. What if the risk is undefined (as in case of a short stock). Besides in general capital committed to a trade can be greater or less than it's risk.
 
ROI is precisely that: 'return on investment', not 'return on risk'. What if the risk is undefined (as in case of a short stock). Besides in general capital committed to a trade can be greater or less than it's risk.

The risk is defined in the case of ICs, which is the margin being the capital commited, therefore it is essentially the same thing in this situation.
 
Quote from falcon:

I must be missing something as I have always interpreted ROI as precisely that, how much one can make on what is at risk. Which would mean 10,000 at risk generating 2,000 would be 20%.
More...
Yep, that what ROI is and it's only useful for comparing different investments as well as results. It's a metric for a single investment.

Don't confuse annualized return with annual return.
 
Quote from falcon:

I do however understand what you are saying about the ROI for the overall account and it's importance however I can't seem to figure out why 5 -10% per month was deemed unrealistic when in fact on a 10,000 position earning lets say even less than 2,000 (make it 1,000) then having 50 ICs on would potentially give you 5,000, which equates to 5% on risk margin added to the remaining 50,000 in your account doing nothing would be 5% on the overall account. Seems reasonable and realistic enough. What am missing here?
More...
Earning an ROI of 5-10% month from one position is a reasonable expectation.

Expecting that you readily earn that for 12 consecutive months without a draw down is a big expectation.

Envisioning that your account will grow 5% a month for an extended period of time (say a year) is an almost unrealistic expectation. It happens but it's an anomaly.
 
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