Posts Tagged ‘Option Spreads’

Welcome! Here you’ll find education on option spreads trading, market updates, option trading videos, and much more! Erik Epp is a veteran options trader. We hope you find his insights helpful to your own options trading.

1) We only report results for suggestions that were actually filled – not hypothetically.  After all, getting filled is what counts and you can’t get worse fills than suggested because our suggestions are based on ‘limit price’ and when filled confirmed by “autotrade” brokers.  A lot of other publications will base their results on hypothetical or unrealistic prices, such as best possible price or “average” fill price, even if there were very few contracts available at that price.

2) We report results based on the suggested ‘limit price’. We realize that some of our suggestions may get filled at a better price than suggested but we choose to report results based on the ‘limit price’ which reflects the “worst case scenario”.  It ensures that anyone can realistically get filled.

3) We include the “cost of doing business” which happens to be brokerage costs associated with trading.  These costs, i.e. commissions, can make a big difference to the dollar and percentage returns and therefore your brokerage account dollar figure.

Comparison #1: Reporting based on suggested limit price vs. actual fill price

Let’s assume that on March 4, 2010 we made a 10 point credit-spread, or credit option-spread suggestion on XYZ for a net price (limit price) of $0.50.  Let’s also assume that one of the autotrade brokers filled the suggestion @ $o.64. 

Comparison #2: Reporting including commission costs vs. no commission costs

Let’s say you want to spend $1,000 on an options-spread trade.  The number of contracts you will be able to trade is determined by the price of the option.  You get a suggestion to open an option-spread on XYZ stock for $0.50 per share.  The option price goes up in 2 days to $0.65 (a 30% increase) and you get a suggestion to sell it.

 * There are two legs for each spread.

As you can clearly see, not all “Track Records” are the same; it’s like comparing apples to oranges.

ROI (Return On Investment) or CRM (Cost Reduction Method)

Let’s assume that you bought a house for investment purposes and you are going to rent it.  Let’s also assume you paid $100,000 for it  and that you rent it for $1,000 per month.  How would you report the rental income and how would you report the gain or loss when you sell the house?

ROI – $1,000 per month / 100,000 cost = 1% income (or gain), or 12% per year, a pretty good return.  Let’s assume that you did that for 3 years for total gains of $36,000 (12,000 X 3) or 36% gain on your investment.  Let’s also assume that at this point you sold the house for $120,000 or $20,000 gain.  Total gain = 36,000 + 20,000 = $56,000 or 56% ROI (56,000 / 100,000 X 100).

CRM – We will reduce the cost of the house by the amount of rent every month (please don’t laugh).  So after 3 years the “cost” of the house will be $64,000 (100,000 – 36,000).  We then sell the house for $120,000 for a TOTAL gain of $56,000 (120,000 – 64,000); the SAME AMOUNT as in the ROI method. Now watch this “magic” math: 56,000 gain / 64,000 “cost” = 87.5% “gain”, an inflation of 56% ((87.5 – 56) / 56) over the ROI gain.

Let’s try this with stocks/options instead. We will substitute buying a house with buying a stock (or option), and from renting to writing or selling calls.  Let’s also drop three zeros from the price.  Here we go:

Buy a stock (or an option) for $100.  Sell an option for one month for $1.  We do this for 3 years and then sell the stock for $120.  After 3 years:  Received $36 in premiums ($1 X 36 month) PLUS $20 gain on the stock for a total of $56 gain.

ROI method:   56 / 100 = 56%

Most advisories use the CRM reporting method which is nothing more than playing with numbers and inflating the percentage results.  KISS Options uses the ROI reporting method.  Which one would you rather have, the sizzle or the steak?