A fellow (with years of experience in trading) asked me to see if I can help him in potentially improving upon his trading (in the sense of learning, doing better, etc). He has had (to various degrees) some of the problems that some traders experience. I suspected that if there is any problem, it would be hidden somewhere in the knowledge layers of a trader's mind.
I asked to review some of his trading history. I noticed that he bought some option calls here and there. That lead to the detection of various "diseases" in his trading approach and how to cure them in regular trading not involving options at all.
One of them was simply that he did not understand the implications of how he calculates breakevens!
He showed me many of the well-known books where it is shown how to calculate breakevens (which is take strike price + premium paid), and he was sure of what he was doing that we even had a heated argument. At that point, I knew exactly what went wrong with some of his trading, which opened the road to curing them.
Many of the bad trading habits that were hard to remove/realize were mainly rooted in not grasping the implications of how one thinks of breakevens and calculate them!
Before I tell (for those who may not know) how to really calculate/think of breakevens, and how that can fundamentally change someone's trading, I wanted to ask ET members (particularly the newbies and those with potential trading problems) how do you calculate your breakevens?
Consider a 100 day 90 strike call (with delta around 0.20), with underlying around 80 when call is bought. The cost of the call option is around 1.25.
If you were to determine the breakeven for buying the above call and holding until expiration, what would the breakeven be? (you can skip commissions, etc, for the sake of learning and ease of calculations).
If you do not trade options and/or never did/will, do not underestimate the lesson you may learn if you were to calculate the breakevens!
Well I seem to be infected with the disease, but this is how I determined my break even:
100 day 90 strike call, delta around 0.20, under lier around 80, cost is around 1.25.
Strike Price + Premium
The stock would need to break the $91.25 mark.