VTS Community

I apologize ahead of time to anybody who doesn’t like math and numbers.  Before you click away, I’ve tried to make it simple so please give it a chance.  It’s a pretty important topic and many of you have asked about similar calculations.  You don’t to study it but just follow along with the basics because it’s especially relevant in the option trading world with respect to performance reporting.

 

It’s pretty common for me to get sent some monthly performance numbers from other option traders and be asked to give my opinion and in the vast majority of cases they are incorrectly recording performance.  They are nearly always recording performance based on return on capital per trade rather than return on the entire portfolio.  Let me show you why this matters with an example from our VTS Discretionary Strategy.

 

In April 2018 the strategy recorded a monthly gain of 3.51%.  Let’s break down exactly why the return was 3.51%.

The VTS Discretionary Strategy started with a 25,000 model portfolio.  Since I don’t give out personalized investment advice on allocation sizing, VTS community members can just scale their own account size to the model portfolio.  If you’re trading with more you can add more contracts.  If you’re trading with less you can take smaller positions.  Again I always recommend paper trading for anyone not familiar with option trading, just to get your feet wet.

The strategy saw a return of 1.34% in March, taking it to a value of 25,335.  (25,000 * 1.0134).  Here are the trades that were officially recorded for April:

Trade #3:  10 x SPY bull put spread
Sold at 1.23 and bought back at 0.44 for profit of 0.79
0.79 x 10 contracts  =  790
trade fees:  34
trade profit:  756.00$

(trade fees are an average of the major brokers and I’m using 7$ per trade transaction and 0.50$ per option contract.  Put spreads are 2 legs, so 10 contracts becomes 20.  We opened and closed the trade, so we paid for the full round trip.  2 transactions at 7$ each plus 40 total option contracts at 0.50$ each)

 

Trade #4:  7 x GLD long straddle
Bought at 3.73 and sold at 3.83 for profit of 0.10
0.10 x 7 contracts = 70
trade fees:  28
trade profit:  42.00$

Trade #5:  1 x CVS covered call
Sold at 1.00  (covered call premium is collected immediately)
1.00 x 1 contract = 100
trade fees:  7.50
trade profit:  92.50$

Total trade profit:  890.50
Model portfolio value:  25,335
(890.50 / 25,335 = 3.51%)

April 2018 return:  3.51%

 

So pretty easy right?  We use the actual dollar amount earned in that month of trading divided by the total amount we’re trading with to determine the return.  As I said though, it’s extremely common for option traders out there and other subscription services to use an average of the return on capital per trade.  Does it matter?  Yes, a lot.  Let’s look at the return on capital per trade now.

 

Trade #3:  10 x SPY bull put spread
trade profit:  756
margin required for that trade:  3,770
return on capital:  20.05%

 

Trade #4:  7 x GLD long straddle
trade profit:  42
margin required for that trade:  2,611
return on capital:  1.61%

 

Trade #5:  1 x CVS covered call
trade profit:  92.50
margin required for that trade:  6,750
return on capital:  1.37%

Average return on capital for those trades:  7.68%

 

So yes it matters, A LOT!  And remember most option services aren’t trading covered calls which are relatively margin intensive because I’ve included the underlying shares as well.  Most services are mostly using credit spreads like put and call spreads or iron condors which typically have very large return on capital numbers per trade.  If we traded two or three put spreads in a month and used return on capital, that could very easily come out to a 10-15% monthly gain, but obviously in real dollar terms it wasn’t even close to that.

I calculate performance exactly the same way for the VTS Iron Condor Strategy.  Actual real world dollar returns that include all unallocated cash and trade fees.  What you see is what you get.  However if I were to start using an average of return on capital, the performance of that strategy would very quickly go from the 18% annualized it is now, to something in the mid 40’s annualized.  It would be highly misleading to use ROI.  Option trading doesn’t work that way.  We hardly ever allocate the full amount of money, and return on capital doesn’t reflect actual dollar values because every trade has different margin requirements.

 

So the next time you are perusing option trading performance, make sure you ask how that performance is being calculated.  Is it real world dollar amounts that reflect all unallocated cash and dollar profit on the full portfolio?  Or is it using highly misleading return on capital per trade?

I’ve seen plenty of option trading services that advertise 30-40% annual return, but when you actually calculate what it would be in real dollars, often times it drops to single digits.  This article is long enough but at some point in the future I will do a part 2 and actually show you a few.  I’ll remove the names to protect their reputation, but I’ll show you how big a difference this common error can make.  Going from returns that are eye popping to sub-standard depending on how it’s calculated…

 

Current VTS Total Portfolio Solution Allocations

10% VTS Conservative Vol Strategy  –  Optional replacement for lower risk tolerance investors

10% VTS Aggressive Vol Strategy  –  Optional replacement for higher risk tolerance investors

50% VTS Tactical Balanced Strategy

20% VTS Iron Condor Strategy

10% VTS Discretionary Strategy

Temporarily paused:  VTS Tactical Volatility Strategy

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