Online Options Trading – Portfolio Measures and Trading Performance Metrics

The profit premium and risk of loss for retail options trading must be managed at two interconnected levels of performance: portfolio and trade specific.

At the portfolio level for online options trading, there are 3 types of goals that need to be set even before you trade.

Maximum return target: complete attainment of the “ideal” level. Dream of the “ideal” that takes you beyond the practical. For example, earn 2-3 times your monthly living expenses with the monthly trading profit. This is meant to stretch your imagination far beyond mediocrity. Even if you fail, you might end up with more than your original goal.

Minimum return target: the lowest acceptable level achievable under most conditions, barring a catastrophic market event. Use the S&P 500’s historical annualized return of between 10% and 12% (before the 2008 financial pandemic) as the lowest acceptable limit. The S&P 500 is a widely accepted benchmark for trading stocks and is a good basis for the minimum target, although your portfolio must be profitable – it doesn’t count to be ahead of the $SPX in negative territory. Below the historical annualized yield range of 10% to 12% is the 3-month T-bill, currently close to zero. While the T-Bill is theoretically an “absolutely” risk-free investment, even the safest investments still carry some residual risk, no matter how small that risk is. The point is this. They’ve been digging into options and all that Greek terminology, not to make salads; but to beat the performance of equities as an asset class. If your portfolio’s return is anywhere from near-zero risk to 10% to 12% per year, you’re only delaying reaching a pain point that indicates a failure to capture basic risk control ability. If your portfolio returns are between 0% and 12% and you plan to continue trading options, processes within your trading process need to be revised.

“Stop Trading” objective: cumulative losses reach an absolute amount below the hurdle rate, necessitating a complete halt to trading for a period of time. 10% of [(60% x Cash Balance at the start of the year); or Net Liquidating Value]. For eg. for a $50,000 trading account, 10% x (60% x $50,000) = $3,000 in total losses is the absolute amount to stop the trade. Why 10%? Inflating your self-funded capital is final. There is no bailout as a home options trading firm does not have access to bank loans; or equity to fund your personal trades.

Now look at the Trade Specific Performance Measures.

Even before you calculate the key figures, it is typically these characteristics that make up a consistently managed portfolio:

  • The biggest loser doesn’t erase the biggest winner. The biggest winner should be a multiple of the biggest loser, e.g. B. 2-3 times more.
  • Above the biggest loss, there are many more winners with progressively higher win values ​​than the biggest loser’s value.
  • Profits should gradually increase depending on the size of your account. When it comes to tens of thousands, the wins should rise steadily like a ladder from the low hundreds to the higher hundreds; then rise from the higher hundreds into the thousands. If your account is over $100,000, profits should go from the high hundreds into the thousands. Wins jumping from low hundreds into the thousands signal an over-reliance on gapping games that aren’t helping you consistently produce profitable results.

Where can I see this increase feature in a consistently profitable portfolio with these portfolio ratios and trading performance metrics? Follow the link below titled “Consistent Results” to see the portfolio of a model retail options trader exhibiting these characteristics.

Let’s get to the hard metrics. There are two ways to calculate the return on your trading capital.

  • The first option is to take the trading account’s total profit and divide it by the year-to-date cash balance as of 01/01/YYYY.
  • The second option is to divide the total profit of the trading account by the running net liquidation value.
  • In either case, you can subtract the total cost of commissions from the total profit to get a total net profit figure. Then divide the total net income by the beginning of the year cash on hand; or Net Liquidating Value. The Net Liquidation Value tells you how much your entire trading account is worth, which is Total Cash Value + Option Value + Stock Value + Commodity Value + Bond Value. The cash balance at the beginning of the year is straightforward – it’s the money in the account at the beginning of the trading year. Cash increases when you are short on securities; but cash decreases when you go long stocks.

To check your performance, calculate these metrics based on your account’s profit (wins) and loss (losers):

  • Win/Loss Probability: is the number of wins divided by the total number of trades. The other way to express this win/loss ratio is to take the number of wins and divide it by the number of losers. The win/loss probability; or wins per 1 loss measures your ACCURACY in selecting trades.
  • The average win is equal to the sum of all wins divided by the number of wins.
  • The average loss is equal to the sum of all losses divided by the number of losers.
  • Average profit divided by average loss measures how RESPONSIVE you are to take profits and reduce losses.

Combine the accuracy ratio with the responsiveness ratio to get your performance ratio. Performance Ratio = (Win/Loss Probability) x (Average Gain / Average Loss). Always try to keep the performance ratio above 1.00. Why? The well-known money management rule is to allocate 2% to 5% of (60% x the account’s Net Liquidating Value) per trade. What is not commonly practiced is the discipline of moderating a trading allocation of +/- 1% between the 2%-5% allocation.

  • If you allocate 2% per options trade you would increase this by +1% to 3% if you can keep your performance ratio above 1.00 for the next month. You would then increase +1% for each month you exceed 1.00 until you reach the 5% cap.
  • If you allocate 2% per option trade, if you fail to keep your performance ratio above 1.00 for the next month, you would decrease that by -1% to bring it down to 1%. You would leave the allocation per trade at 1% for each subsequent month until you are able to fix your performance ratio above 1.00 to increase the allocation per trade by +1% again.

This allows you to create a ladder effect by increasing profits and decreasing losses. This move up and down mechanism is an indispensable tool for rewarding wins and disciplining the risk of loss. It forces you to improve both ACCURACY and RESPONSIVENESS before increasing your position size.

Where can I learn more about portfolio metrics and trading performance metrics as part of an overall trading system? Follow the link below for 55 hours of video-based learning about online options trading from the comfort of your own home.