return calculations

lightrader · Feb 17, 2012

Hi, basic question - when calculating return on margin for a certain month (let's assume that the account only includes short options), do you devide the monthly aggregate p/l by the average margin required for these month to get the return in %? Or do devide the p/l by the entire funds that were in the account (even if they were not necessary for margin purposes)?

Also, if during the month funds were added or removed from the account, so that the return is calculated separately for each period in which the cash was different, how do you make the adjustments which are necessary to get the accurate risk parameters (such as STD, drawdown) for this month? For example, if the account value was 50k and then 20k was removed from the account, so that it is now 30k, so there was no a real drawdown or a change in the market values but the 20k decline was only due to the cash removed, how would you calculate the risk factors? I think that as the return is calculated separately for any period in which the cash was different, also risk factors (such as drawdown) should be calculated seprategly for any such period, but I am not sure.
Appreciate your help, thanks.

lightrader · Feb 18, 2012

Any reponse, please?

gkishot · Feb 18, 2012

Quote from lightrader:

Hi, basic question - when calculating return on margin for a certain month (let's assume that the account only includes short options), do you devide the monthly aggregate p/l by the average margin required for these month to get the return in %? Or do devide the p/l by the entire funds that were in the account (even if they were not necessary for margin purposes)?

Also, if during the month funds were added or removed from the account, so that the return is calculated separately for each period in which the cash was different, how do you make the adjustments which are necessary to get the accurate risk parameters (such as STD, drawdown) for this month? For example, if the account value was 50k and then 20k was removed from the account, so that it is now 30k, so there was no a real drawdown or a change in the market values but the 20k decline was only due to the cash removed, how would you calculate the risk factors? I think that as the return is calculated separately for any period in which the cash was different, also risk factors (such as drawdown) should be calculated seprategly for any such period, but I am not sure.
Appreciate your help, thanks.

When calculating your return you divide account value at the time position is closed by the account value at the time position was opened ( save deposits and withdrawals) .

opt789 · Feb 18, 2012

Your first problem is that you mention shorting options, so I assume you are naked. Now it appears you want to put together a track record to show people. Do you have any idea what kind of can of worms you are opening up? Do you know anything about the regulations and many, many laws involved with this? You are not allowed to tell anyone about a track record for any reason unless you following all the governing rules.

But to answer the question, you have to divide your profit or loss by all the money in the account â otherwise what is the point of the money being there. Most traders are ludicrously overleveraged and that is why they donât survive, so having adequate reserves in your account is essential. You cannot ever add money to the account to cover a trade, if you did you were never really just trading with the money in the account, you were trading with that plus whatever money is added and it shows you are an amateur that should not be trading otherâs money. To give some reference, it is normal for futures traders who manage OPM to measure their margin to equity ratio which is just your initial haircut divided by the money in the account. A conservative number is 10% with 15%-25% being somewhat normal or average, and anything over 30% is high and dangerous.

As for normal adding and withdrawing money you have to establish a consistent rule and follow it. You can say any money added in a month counts for next month, and any money taken out during a month does not count for that month, or something like that. It will depend on your trading style and other factors, you just have to come up with something that makes sense and follow it.

lightrader · Feb 19, 2012

Quote from opt789:

Your first problem is that you mention shorting options, so I assume you are naked. Now it appears you want to put together a track record to show people. Do you have any idea what kind of can of worms you are opening up? Do you know anything about the regulations and many, many laws involved with this? You are not allowed to tell anyone about a track record for any reason unless you following all the governing rules.

But to answer the question, you have to divide your profit or loss by all the money in the account â otherwise what is the point of the money being there. Most traders are ludicrously overleveraged and that is why they donât survive, so having adequate reserves in your account is essential. You cannot ever add money to the account to cover a trade, if you did you were never really just trading with the money in the account, you were trading with that plus whatever money is added and it shows you are an amateur that should not be trading otherâs money. To give some reference, it is normal for futures traders who manage OPM to measure their margin to equity ratio which is just your initial haircut divided by the money in the account. A conservative number is 10% with 15%-25% being somewhat normal or average, and anything over 30% is high and dangerous.

As for normal adding and withdrawing money you have to establish a consistent rule and follow it. You can say any money added in a month counts for next month, and any money taken out during a month does not count for that month, or something like that. It will depend on your trading style and other factors, you just have to come up with something that makes sense and follow it.

Thanks for the response. Not everyone who shorts options is basically "naked", especially if he keeps enough cash aside to buy the stocks in case of assignments.

I want to emphasize that I mentioned adding or removing cash so that there will not be a large amount of redundant cash in the account, but the added money will be up to the maximum amount that I can trade with. For example, if my available capital is 100k, and currently the margin requirements are only 20k, I want to keep in the account something around 25k and add capital (from the remaining 75k) as long as there is a need due to an increase in margin requirements, and vice versa regarding removing cash when margin requirements are substantially reduced. And therefore I wanted to understand how can I calculate drawdowns, std, etc. when the account value changes only due to adding/removing cash as mentioned above. I guess you are right and I should follow a certain constant rule (such as calculating drawdowns or std separately for each period in which there cash was added/removed from the account).

gkishot · Feb 19, 2012

Quote from lightrader:

Thanks for the response. Not everyone who shorts options is basically "naked", especially if he keeps enough cash aside to buy the stocks in case of assignments.

I want to emphasize that I mentioned adding or removing cash so that there will not be a large amount of redundant cash in the account, but the added money will be up to the maximum amount that I can trade with. For example, if my available capital is 100k, and currently the margin requirements are only 20k, I want to keep in the account something around 25k and add capital (from the remaining 75k) as long as there is a need due to an increase in margin requirements, and vice versa regarding removing cash when margin requirements are substantially reduced. And therefore I wanted to understand how can I calculate drawdowns, std, etc. when the account value changes only due to adding/removing cash as mentioned above. I guess you are right and I should follow a certain constant rule (such as calculating drawdowns or std separately for each period in which there cash was added/removed from the account).

This is simple: You actively trade with 25K and you keep 75K in reserve then your returns are calculated off 100K of total account value. No shortcuts.

opt789 · Feb 19, 2012

Quote from gkishot:

This is simple: You actively trade with 25K and you keep 75K in reserve then your returns are calculated off 100K of total account value. No shortcuts.

Correct, but what is the point? If this is your money trading for yourself, why would you possibly care about exactly what your returns are? The only reason is to show it to other people, which I pointed out earlier is illegal except in specific cases and in very specific ways dictated by the appropriate governing authorities. If you plan on showing the returns to someone at some point then you need to learn what the rules are, and what the CPA is going to need to audit your returns. It is best to set up everything correctly first, and keeping all the money in the account that is being figured in the calculations is probably best. How do you explain to an auditor that you are keeping money in âreserveâ? How can you prove it, track it, etc?

lightrader · Feb 19, 2012

Quote from opt789:

Correct, but what is the point? If this is your money trading for yourself, why would you possibly care about exactly what your returns are? The only reason is to show it to other people, which I pointed out earlier is illegal except in specific cases and in very specific ways dictated by the appropriate governing authorities. If you plan on showing the returns to someone at some point then you need to learn what the rules are, and what the CPA is going to need to audit your returns. It is best to set up everything correctly first, and keeping all the money in the account that is being figured in the calculations is probably best. How do you explain to an auditor that you are keeping money in âreserveâ? How can you prove it, track it, etc?

I may have misunderstood this issue, but I thought that returns are calculated just on the margin that was actually required (or the average margin during the period). This may have a material impact in certain situations. For instance, if the trading capital of a proprietary trading firm is basically borrowed money, on which they pay interest, it should make a material difference regarding borrowing the 100k upfront or borrowing only 25k, so that the remaining 75k can be borrowed at a later time. In suce case, I am not sure that the return should be calculated on the 100k, since 75k of it was not used and may not be used at all, so I thought that the return is calculated by dividng the p/l by 25k (assuming this is the average margin requirements).

opt789 · Feb 19, 2012

Quote from lightrader:

I may have misunderstood this issue, but I thought that returns are calculated just on the margin that was actually required (or the average margin during the period). This may have a material impact in certain situations. For instance, if the trading capital of a proprietary trading firm is basically borrowed money, on which they pay interest, it should make a material difference regarding borrowing the 100k upfront or borrowing only 25k, so that the remaining 75k can be borrowed at a later time. In suce case, I am not sure that the return should be calculated on the 100k, since 75k of it was not used and may not be used at all, so I thought that the return is calculated by dividng the p/l by 25k (assuming this is the average margin requirements).

Again, you have yet to state why. Without the why there cannot be a complete answer. I remember other threads here where people get into long drawn out and complicated debates on how to calculate returns for different situations, so not every trader will give the same answer. If the info is for you, do whatever makes you happy. If others will look at it then you need to figure the return on any and all money used or any money that might be used, even if it is a remote possibility. If there is any conceivable way that money could be brought in to maintain or adjust a position for any reason whatsoever then all the capital must be used in your computations. I donât know any professional who measures their performance based solely on minimum exchange margin.

You can look at different returns by comparing profit potential to margin requirements for various trades and use that information to allocate capital, but no one reports monthly or annual returns based just on the margin requirement.

lightrader · Feb 20, 2012

Quote from opt789:

Again, you have yet to state why. Without the why there cannot be a complete answer. I remember other threads here where people get into long drawn out and complicated debates on how to calculate returns for different situations, so not every trader will give the same answer. If the info is for you, do whatever makes you happy. If others will look at it then you need to figure the return on any and all money used or any money that might be used, even if it is a remote possibility. If there is any conceivable way that money could be brought in to maintain or adjust a position for any reason whatsoever then all the capital must be used in your computations. I donât know any professional who measures their performance based solely on minimum exchange margin.

You can look at different returns by comparing profit potential to margin requirements for various trades and use that information to allocate capital, but no one reports monthly or annual returns based just on the margin requirement.

I want to do it first for myself, but if the results will be satisfactory I may use it in the future as a track record (and I know that there are many rules regarding this subject). Anyway, I prefer to do it in the right way from the begining.

Just one more question regarding the added capital issue - if I add capital to make new trades (and not to cover margin req), and I bring this capital from new money which is out of the account, which I did not intend previously to trade with (or which I just now earned as an income), I assume that you would not say that this amount should be included in the return calculation also regarding the period before the money was added to the account. Is that correct?