Profit and Loss calculations, and working outbreak-even points, are an important part of managing your trades. Do you know how much true profit you are making in a trade? How do you know when you have broken even? Options trading is MUCH more expensive than stock trading, and broker commissions can eat into your hard-earned profits. The great thing about options trading is the number of different strategies available, but different trading strategies have different calculations. Here is where you will learn how to calculate your true profit for a trade, and how to know when you have broken even.
- Profit and Loss Calculation for Stock trading
At the simplest level, you simply calculate the amount of value by which the stock has grown, and record it as a percentage.
So, if you purchased 100 shares of a stock worth $25, your total trade is $2,500. If your stock climbs to $28, you have made $3 profit per share, which is 12% profit. Or, your total trade is worth $2,800, which is $300 profit, and is still 12%.
Your TRUE profit however, must include broker's fees and commissions. So, for a stock trade, you may pay $0.015 per share to your broker. The above trade would therefore work out as follows:
Buy 100 shares @$25 = $2,500 + $1.50 = $2,501.50
Sell 100 shares @$28 = $2,800 - $1.50 = $2,798.50
True profit = $2,798.50 - $2,501.50 = $297 = 11.88%
Your break even point is $2,503, and you are only into profit zone AFTER you have crossed that threshold. You need to take the costs of both the purchase AND the sale of the stock into account, because you only realise your profit AFTER you sell the stock.
So, what's the big deal? You total trade cost $3, or you dropped 0.12%. Small change!
Well, with options, it is a big deal, because options are expensive to trade in the first place, and as soon as you start working with combinations like spreads and butterflies and so on, the commissions rack up pretty quickly. This is offset by the huge profit potential of options, but you still need to calculate it so that you know what your true profit is. So, onward....
- Profit and Loss calculations when Buying Calls and Puts
Most brokers charge a flat fee (say, $9.95 per trade) and an additional fee per contract (e.g. $1.50). Discount brokers charge less, but there is always a reason for that - you usually have fewer strategies available, or trades take longer to fill. Assume that the figures I am using are the maximum your broker will charge you, and then click on the link to see how to do the calculation:
- Profit and Loss calculations when Selling Options
When selling options, your calculation is not based on the cost of the investment (ROI = Return on Investment). Instead, the broker requires you to hold a margin in place to cover you if the trade goes wrong, and you are forced to buy a bunch of stock, or sell a bunch that you don't own and must cover. So, the calculation is based on "Return on Margin", or ROM. Click on the link to see exactly how it works.
- Profit and Loss calculations when Selling Credit Spreads
As with selling options, your profit calculation is based on ROM, or "Return on Margin". This can get expensive: a credit spread has two legs, or effectively two option trades. A butterfly or Condor has four legs, so four trades to pay for when you buy, and another four when you sell. Ouch! However, your broker will often charge a flat fee of $9.95 for the whole trade (no matter how many legs), and then $1.50 per contract per leg. Click on the link to see how...
(NOTE: I am using the rates given by ThinkorSwim, which is the broker that I use. OptionsXpress and Interactive Brokers have slightly different formulae)
On my Review page, I have about 80 sites listed which provide option trading recommendations, many of which will offer autotrading services with ThinkorSwim and OptionsXpress. Thisis great tool to help you choose such a service - all the basic data are there.
Options trading leads to substantial, exciting and spectacular profits. However, broker's fees are much higher than for stock trading, so be realistic about your profits. Also, there are myriads of newsletters out there giving great looking performance results. Make sure your read the small print, and make sure the brokers fees are factored in before choosing any particular provider.
When you sign up with a broker, make sure you know what their fees are running at. You sometimes have the opportunity to choose from several fee structures - make sure you choose the one that suits your trading level the best. You can see all the information you need about fees and commissions for each broker on the page about Best Option Brokers.
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