Best way to annualize yield from naked puts?

Discussion in 'Options' started by ferrycorsten, Mar 9, 2013.

  1. Let's say underlying is $50 and a put with ten days to expiration is selling for $1. Do you annualize based on calendar or trading days (2%*~36 or 2%*25)?

    Now assume you're supposed to use calendar days and wanted to use a formula that takes compounding into effect. Is this the proper way to do it...(1+(1/50))^36-1) = 1.04 i.e. 104%?
  2. I divide 365 by 10 days = 36.5
    I divide the strike into 100 = 2
    I multiply those results by the credit.

    Hence..... 36.5 X 2 X $1 = 73%.
    However, annualizing such S-T trades are meaningless.
    I don't bother calculating annualize trades less than 3 weeks, as the results are always super high and super meaningless.
    For such short term trades I focus more on dollars earned.
  3. newwurldmn


    It's just as valid to annualize 10 day option returns as 3 week option returns. The implications are the exact same.
  4. Personally, I don't bother if it's not more than 3 weeks.
    If you do a bunch of btrades through the year averaging 2 weeks, and they all yield 70%, you'll probably end the year earning closer to 20%.
    So what was the point and relevance of all those 70% returns?
    Why the discrepancy?

    The shorter the trade the more meaningless, as there will be too many days of no trading between trades, as the year progresses.
    The more trading day gaps between trades, the more meaningless the results, as it applies to potential year end results.
    And of course, the more trades, the more commission costs.

    Feel free to annualize 3 day trades, if you want to be really impressed with super larger annualized % returns.
    But due to the HUGE number of trading day gaps between those 3 day trades, don't be surprised if your 100% returns on those, are translated into 15% results by year end.
    And it's those year end results that matter.
    Not this or that particular trade you made on this or that day.
  5. newwurldmn


    The same case exists when you sell 1 month options or even 3 month options. Are you saying that you are able to continously reinvest your money? If so, what prevents oldnemsis from doing it or the 10 day option seller?

    FWIW, I don't annualize any returns.

  6. your not living in reality doing it like this....
    the risk premium in the put your selling is actually unknown and only market speculation.. the market puts a price on the option... what the value ends up being is something completely different..
    your taking a market speculated price and trying to track it to some time based return.. as if its a train going down a track at the same speed with no changes..
    and in the Black scholes world.. you could never make money selling puts .. over time the premium in the put ends up putting you at break even over many trades..

    The downside of the distribution might be way undervalued.. you could end up going broke on trades like that

    you need a model of what you speculate the risk premium to be in your strategy relative to what the market is pricing it at.. then over many trades you can extrapolate an edge.. its like how good are you at picking a expensive side of the future distribution of returns.. or how good are you at valuating forward realized volatility as it shows up in the implied volatility of the options..
  7. One should assume there will always be breaks between trades.
    But the shorter the trades, and thus the more frequent the breaks between trades, the more trading day gaps will result.
    And the more gaps there are, the less accurate the "blend" of your annualized returns will turn out to be at year end.

    If you are earning 20% with each trade, and each trade only last 2 weeks, and there are 7 days gap between those 20% return trades,.... don't expect to have earned 20% on your account value at year end,.... even though you earned 20% on each trade.

    On the other hand of your trades last 2 months, with the same 20% return per trade, with the same 7 day gap between trades, you will earn extremely close to 20% at year end.

    Do a one year LEAPS that earns 20% and you will have earned 20% on your account cash at year end.

    And of course, being on margin, which I am, also helps to fill in those trading day gaps.
    Hence the reason i earned over 22% last year, even though most of my trades paid 13 - 19%.

    I'm shocked that you don't annualize or have some kind of "benchmark" you use to evaluate the R/R of your trades.
    Everyone should have some kind of "standard minimum benchmark", to evaluate whether the trade risk is worth the potential reward.

    There are plenty of trades I pass up, because they pay below my minimum benchmark of 12%.
    (When the VIX rises, I'll then raise my minimum benchmark).
  8. I assume that Ferry is looking at the compounded yield to ascertain the feasibility of individual positions (is my guess) or the strategy as a whole. I would much rather manage a short put portfolio than a passive stock portfolio. But there is no utility in the number.
  9. Sorry PM, you lost me on step two. I never actually gave a strike, just said the underlying was at 50. Do you use the strike of the put, or the underlying price for the calculation?

    cd, i take it you are not a fan of naked puts?
  10. If I'm dealing with options, I use the strike.
    Afterall, the underlying will fluctuate.
    The strike is stationary.... unless it gets put to you.
    But then the trade is over..... until a new one is initiated.
    #10     Mar 9, 2013