Whenever I communicate to my readers about my opening option trades, I have the habit of posting the expected annualised ROI in the title or subtitle. ROI is one of the calculations that can also be very helpful but it can be very misleading too. I’ve been using the non-compounding return on investment calculation to post the expected annual return on my options trades. With this in-depth research article I want to explain the reasoning behind my calculations and find confirmation that my approach to ROI is entirely correct.

ROI calculations are basically quite simple. They are universally used and understood, they help us to decide whether to take or skip an investment opportunity and they help us to determine the performance of an investment.

Annualising ROI allows us to make a comparison between trades of different duration. Investors like to compare investment results. And they should!

As stated before, ROI percentages are used in headlines and post titles every day, but are we sure that the mentioned ROI are truly correct and representing what we think?

Numbers always need to be put into perspective (are they compounded or not? and what amount was used for the investment factor? ,…).

While the ROI formula itself is simple, the real problem often comes from people not understanding and defining correctly the investment factor involved. In this article, I will also try to figure, out in regard of my options trading, how this investment factor needs to be determined and give you my take on it.

Broad approach at portfolio level

If you look at the portfolio or account level, it looks quite easy to determine the return on investment. For my portfolio for example, I can basically look at the value amount at the end of a specific period and subtract the value amount at the start of the period, and then divide the difference by the beginning value amount.

Imagine the value of my account was $50,000 at the start of the period (you can follow my account size and account results here), and on the last day of that period the value of my account is $60,000. The return of the investment done is $10,000 and the ROI over the considered period is (60,000 – 50,0000)/50,000 = 0,20 or 20%.

Nice return right? Hard to tell of course! The information that is key to evaluate here, to see if I’ve made a good investment or not is the factor TIME. The considered period of time is an important element in this evaluation. When comparing two investments, we need to compare the two trades in the same time period. Obviously, a return of 20% in 5 days is much better than a return of 20% in one year! This is easy to understand.

The trick here is to recalculate both investments to the same time basis and the annualised return is very often used and in general a fair way of comparison for investments. It also allows the comparison of the ROI of our bank accounts … which used to be something.

The formula I use for the annualised ROI for my options trades = (Net Profit/Investment)/(number of investment days/365). As mentioned, I’ve been using the non-compounding return on investment calculation for options trades because I don’t consider that the return (the premium) I have, gets re-invested immediately. Compounding the return will actually give you a higher annualised ROI, but is in my opinion misleading.

So imagine a positive increase in the value of my portfolio of a $1,000 after only 25 days. And the starting value of my portfolio was $5000. This equals a ROI of 20% over 25 days. The annual ROI in % at portfolio level would be [(return/investment) x 100] x (365/number of days of investment) = (1000/5000) x 100 x (365/25) = 292%.

Obviously this annualised ROI is correct and realistic if I can continue to create returns at the same rate all year long. It is important to realise this. And another consideration to make regarding the correctness of the calculation of the ROI is the fact if the trading costs and fees were taken into account or not.

Considerations about ROI for individual trades

Now what if I want to calculate the ROI of the different individual investments or trades made in my portfolio separately? How do I have to look to the investment when I am dealing with just one trade in an account with multiple trades going on?

The actual return (or the net profit) of every individual trade is easy to determine but what about determining the amount of the actual investment cost? The value of the investment cost is equally determining the ROI result. This means that if we incorrectly determine (even unconsciously) the investment cost, we will significantly arrive at different ROI results. We want to avoid that because obviously we don’t want cheat on ourselves, do we?

So we arrive at the question, what is to be considered as “the investment” of every individual trade?

In the classic sense, Return On Investment is the financial ratio used to calculate the profit an investor will receive in relation to the investment cost. It actually means, just like it literally says, how much net income (profit or loss) you generate, divided by “what you invest (on your investment) or put into it” or also known as the “capital used or reserved”, “capital cost” or “required capital” to make the investment.

This capital required varies depending on the account type used for trading. There are basically two types of trading accounts online-brokers offer to people: cash accounts and margin accounts. Let’s take a look what this exactly means in regard to the investment cost of a trade, and more in particular for selling options.

If you don’t know the difference between cash accounts and margin accounts or you lack thorough understanding, you may want to take a look at my page Cash and margin accounts explained with practical trading examples.

Cash account

In regard to our analysis, the above means for our ROI calculation that the required, reserved capital, the investment for the trade, is equal to the cash requirement for that trade, because this capital is “blocked” (or restricted as Interactive Brokers calls it) by that trade.

Let’s take a look at an example to quantify this:

The annualised ROI will of course only be realised if I can repeat this investment over and over again during one complete year. And as I have already mentioned, I use the non-compounding return on investment calculation for options trades because I don’t consider that the return (the premium) I receive, gets re-invested immediately.

It is quite possible, depending on the broker’s requirement, that the buying power requirement does not take into account the initial credit received for selling the option nor the associated costs of the trade and only takes into account the actual buying of the shares. So this is something you will need to check for the brokerage you use. In case the premium nor the costs are considered, and the buying power requirement is fixed at 100 x $110.00 = $11,000.00, then the annualised ROI would become [((118/11000) x 100) x (365/45)] = 8,70 %. Not a big difference but correct is correct.

Margin accounts

Now let’s take a look how to determine the “investment cost” for a similar trade in a margin account and what it means for our ROI calculation.

The difference between a brokerage cash account and a margin account is a bit like the difference between a debit card and a credit card. Both cards let you buy the things you need and provide easy access to money, but purchases on a debit card are limited by the cash balance in your bank account, while a credit card extends you a line of credit, letting you buy more (potentially much more) than the cash you have on hand.

As stated before, for an each individual trade, the “margin” of a trade is the portion of the total purchase price that is contributed by the trader. There are initial margin requirements and maintenance margin requirements for every trade in a margin account. If these concepts are new to you and you want more info with practical examples, then my page Cash accounts and margin accounts explained with practical examples is a great read.

For our ROI calculations, let’s take an example to understand and see which capital requirement we need to take into the equation.

This means for the ROI calculations of my trades in a margin account that the investment factor is the amount of capital that is block or tied up by the minimum maintenance requirement by the broker for that particular trade.

Now if we look at the maintenance margin requirements for options, we can see that brokers determine these requirements separately based on the type of transactions. These calculations are made on the broker’s platform before issuing a trade.

It is there that I select the maintenance margin requirement as the amount for the investment cost for the ROI calculations. After all this is the capital that is blocked, reserved or required to be able to continue the hold the position.

So in this example (screenshot above), I have entered an order for selling a put option at strike price of $40.00 with 22 days till expiration. I receive a premium of $65.00.

This brings my ROI over the 22 days at (65/403) = 16,12%. And the annualised ROI is [(65/403) x (365/22) x 100] = 268%

So this is basically how I calculate my ROI to make predictions or compare investments.

Whenever you’re ready, here are 3 ways I can help you to improve your option trading:

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2. If you are not a Free member of our discord yet : In our discord channels, we team-up with other like-minded option traders, with the aim to support each other and share valuable insights and ideas. I provide live comments, trade alerts, educational info and tools via our discord room. Join anytime ! here: http://discord.gg/cGW6xH4RNT
3. In case you haven’t found me on social media: I suggest to follow me on X @L2TradeOptions and on Youtube @TradingOptionsCashflow to pick up my latest content.

If you have any question or something to add, please feel free in the comments below.