When you are selling options, the calculation you use to work out your break even point (i.e. the point at which you start to make a profit) and to find out how much profit you have made from a trade is quite different from the one that you would use to calculate break even and profit when trading stocks, or when simply buying selling calls and puts.
To calculate your profit when selling an option (like a naked put, or a covered call), you are not actually investing money in the trade, so you cannot work out return on investment (ROI). However, you will need to put up margin to cover your trade, and so you work out your profit based on Return on Margin (ROM).
Example: Trade 1
Say you sell a Put which is valued at $1.50. You are immediately credited with $150. If you need to put up $1,000 margin* to cover this trade until expiry, your ROM is 15%. If you let the option expire, you only pay a broker's commission ONCE. So, in this case, your profit would be $1502.95 = $147.05, which is 14.7%. If you buy back the option, and sell another, then you pay broker's fees for three trades! It can mount up!
*NOTE: each broker has different formula for calculating margin requirements, some of which are quite complex. I am using a rounded off figure that my broker uses, for illustrative purposes. The actual formula used by TOS is "100% of the option proceeds plus 20% of the underlying stock less any amount the option is outofthemoney". For a comparison of different brokers, go here.
What about break even?
If the strike price for the put is $25, and you sell a put for $1.50, you are credited with $150. If the stock sinks below the strike price and becomes an ITM option, you are not automatically in losing territory. Remember, you have been paid to sell the option. Therefore:
Breakeven = $25  $1.50 = $23.50.
In other words, as long as your stock doesn't drop below $23.50, you are still not making a loss. If you factor in broker's commissions, your break even is:
Breakeven = $25  $1.47 = $23.53
Having said that, it best to NOT let the option that you sold go ITM. I always get out before that, even if there is some gap before the break even line is crossed.
Again, this calculation is for ONE option. When your trade multiple options, your cost per option is much less, and so your breakeven calculation changes each time.
Example: Trade 2
Say you again sell the above naked put, but this time you sell 10 contracts. The broker commission formula is $9.95 plus $1.50 per contract, so the total commission for 10 contracts would be $24.95.
Strike price for XYZ = $25
Sell 10 Naked Puts @$1.50. Total Revenue = $1,500
Profit after commission = $1,500  $24.95 = $1,475.05
Margin requirement = approx $10,000
ROM (Return on Margin) = $1,475/$10,000 X 100 = 14.75%
See more on Selling Options:
See more on Selling Naked Puts:
Return from Selling Options Profit Loss Calculation to the Home Page
