How to Calculate Profit, Loss, and Break-even Point for Option Traders
As an options trader, calculating profits and establishing break-even points are an important part of managing all your trades. You should have a basic understanding of the key concepts, so that you not only know when you are making a profit, but also to be sure that newsletter providers are not leading you down the garden path.
It is important to know that different options trading strategies have different calculations. You need to consider two steps: what is your break-even point (so you know where your earnings start to take effect); and what your profit will be as the trade progresses. Hopefully, you won’t lose, but if you do, you should have a realistic idea of how much you’ve lost!
To start at the simplest level, consider how you would calculate your break-even point and profit for a simple stock trade. Initially, you would simply calculate the amount of value by which the stock has grown and record it as a percentage. So if you bought 100 shares of a stock worth $ 25, your total trade is $ 2,500. If your shares go up to $ 28, you’ve made a profit of $ 3 per share, which is a 12% profit. However, your total trade is worth $ 2,800, which is a profit of $ 300, and it is still 12%.
You CERTAIN However, earnings must include the broker’s fees and commissions. So for a stock trade, you can pay $ 0.015 per share, when you buy and when you sell. Therefore, the above trade would result in your breakeven point for the entire trade being $ 2503, and your bottom line profit if the stock were to go up to $ 28 would be 11.88%.
So what is the problem? Your trade cost $ 3, or it was down 0.12%. Little change! Well, when trading options, it’s 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 etc, the commissions add up pretty quickly. This is offset by the huge profit potential of the options, but you still have to calculate it to know what your true profit is.
How is the break-even point and profit calculated when trading options?
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When buying calls and put options: If, for example, you buy a call option for a share at a cost of $ 250. After a few days, your trade has gone well and the option is valued at $ 500, so you sell, thinking that you have made a profit 100%. Not necessarily! The broker’s fee for this trade could be $ 12.95, or even $ 15 for some brokers. So if you factor in the broker’s fees both when buying and selling, your trade cost could be $ 25.90. This means that your breakeven point is now $ 275.90. In other words, the value of your option needs to increase a little over 10% before you start to make a profit! That’s acceptable, because most traders are aiming for a minimum 50% and usually 100% growth in their trade. However, if the price of your option has doubled, as in this example, you have actually made a real profit of something closer to 80%.
- When selling options: To calculate your profit when selling an option (such as a short sale), you are not actually investing money in the trade, so you cannot calculate the return on investment (ROI). However, you will need to put a margin to cover your trade and therefore calculate your profit based on margin performance (ROM). Therefore, if you sell a put option, the cost of the put option is immediately credited to you. From this, you can calculate your basic ROM. If you let the option expire, you only pay a broker commission ONCE, and you must subtract this from your income from the sale to find your true profit. To calculate your break-even point, you have to remember that you were paid for the option, so you subtract the cost of the option and add the broker’s fees to your ROM.
- When selling credit spreads: The example above was to sell a unique option. Selling credit spreads involves trading not one, but two options: sell one option and buy another. If your broker charges per trade, then your profit and break-even points are calculated exactly as if you were selling individual options (look at ROM, not ROI). If you are charged per option unit, you must double the cost of the trade, and if you let the margin expire, you will only pay a fee. When you buy back the spread and sell another, you pay a fee for each transaction. For a butterfly or iron condor exchange, you are exchanging four options at once, so it gets quite expensive.
Options trading leads to substantial, exciting, and spectacular profits. However, the broker’s fees are much higher than for stock trading, so be realistic about your earnings. In addition, there are countless newsletters that offer excellent performance results. Be sure to read the fine print and make sure broker fees are considered before choosing any particular provider. When you sign up with a broker, make sure you know what their fees are. Sometimes you have the opportunity to choose from several rate structures; be sure to choose the one that best suits your level of negotiation.
