Lesson Overview
Targeting Your Portfolio Returns
Once you have a solid understand of where our "edge" is as traders we can back into how much money you can make trading options or what your targeted portfolio returns might look like for different capital allocations. Again, it's no unreasonable to generate an aboveaverage (Alpha) return on a small amount of your overall capital.
More Discussion
Was This Helpful? Add Comments/Questions

James W

Kirk Du Plessis


Kirk Du Plessis

Marcus

Just me!

Kirk Du Plessis

Kirk Du Plessis

Joshua


Ryan Fisler

Kirk Du Plessis


Kirk Du Plessis

Kirk Du Plessis

andreas


Kirk Du Plessis

Kyle Nelson

Kirk Du Plessis


Jeff Smock

Kirk Du Plessis


Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

John Brewer

Kirk Du Plessis

John Brewer

Kirk Du Plessis

John Brewer

John Brewer

Kirk Du Plessis

John Brewer



Kirk Du Plessis

Ruth

Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

Eric Hansen

magne gronnevik

Kirk Du Plessis

Kirk Du Plessis

Andy

Kirk Du Plessis



Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

Davan Hepburn


Kirk Du Plessis

JohnC


Kirk Du Plessis

Kirk Du Plessis

Leonardo Gomez

Kirk Du Plessis

Hina Bakshi


Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

Anzelle Whitsett

Kirk Du Plessis


Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis

Kirk Du Plessis
In this video, we're going to talk about targeting your portfolio returns and figuring out how much money you can make trading options. Now, at this point, if you're new to our program or are just watching this video, you should understand or have a solid understanding of where our edge is as options traders in selling options.
The concept that implied volatility is always overstated, and therefore option selling is always more profitable than option buying. Before we start talking in depth about finding and entering trades, first we need to have a target to shoot at or something to aim for.
So whether you're new to options trading or not, one of the major questions that people have are the following: "How much money can I make?" Or, "What kind of return can I expect?"
So I want to introduce you to the concept of using targeted returns or targeted probabilities as your guidepost for how you should be placing the majority of your trades in the futures.
Before we even get to that, I think it's insanely important that we first talk about market trade offs, because markets are extremely efficient. And what I mean by that is that if you have a trade where you are taking on less risk, then you will have a lower overall profit.
And likewise, in markets where you're taking on more risk, you're going to have a higher overall profit. It's just how markets work. Risk and profit work in the same directions, meaning lower risk, lower profit, higher risk, higher profit. Okay?
That also means that, with regard to options trading, you're probability of winning and your profit potential work in different directions, or in the opposite direction.
And what I mean by this is that when you increase the probability of winning on a trade ... so instead of having a 70 percent chance of success, you increase that chance of success to 80 percent, your profit potential goes down accordingly.
Again, the markets are efficient here, so when you're going to win more often, your profit potential goes down, okay? And this works in reverse too.
So if your probability of winning goes down, meaning you reduce your probability of winning from say, 80 percent to 50 percent, then your potential profit on those trades that are maybe 50 percent of the time going to win or not are going to be higher when you do win. So your profit potential might be a little bit higher.
This is like a lottery ticket I use as an analogy all the time. Your probability of winning a lottery ticket is insanely low, I mean piratically nonexistent, right? But your profit potential is high because it's in direct correlation and relationship with the probability that you're going to win, so it's all efficient and in fair. Okay?
Now, the reality is ... and this is one nobody tells you in this business, but I want to go through here with you today ... is that you can target whatever return you want annually in your portfolio.
You want a 10 percent return, a 20 percent return, a 50 percent return. But just ask yourself the following: "How much risk will I need to take to make a 50 percent return?" Again, because there's no free lunch, it's not that you can make a return without taking some risk.
So how much risk will you need to take to make a 50 percent return? Or, more importantly, can you handle the volatility in your account trying to get there. And I think that's the more important question that people need to ask.
See a lot of people shoot for the really high percentage annual return on capital, but they can't handle the volatility. They don't have the persistence and confidence to get there. Okay.
Now, I want to use this graph as a quick visual aid because I think it's going to represent the point that I'm trying to make here with your targeted returns, is that, again, you can target anything you want, it's just can you handle the volatility and the risk that comes with that, trying to get to that target.
Wherever you want to be at. So if your target, let's say is 10 percent annually, which is very good, and in all cases, beats the market averages across the board. So 10 percent annual return on your trading, which I think is very very doable. Right?
Your account and portfolio might start here at zero on some timeline. Now this timeline doesn't matter, whether it's days, weeks, years, it's just the concept that we're trying to prove here. But your account balance might start with a zero percent return as you just start funding it.
And then the first month that you start trading, maybe you make five percent. And the next month, maybe you make three percent. And the next month, you make four, and then you make seven, and then maybe one month, you lose maybe eight percent. Or whatever the case is.
You can see that there's definitely some volatility as you're working towards your 10 percent target. And you can get there over time, but you're going to have a certain amount of volatility in your account. A 10 percent return is not taking on a substantial amount of risk.
You're not taking on an insane amount of risk to get a 10 percent return. And actually we're going to prove that here later on in the video with some actual real number and calculations. But you're not taking on an insane amount of risk to get to 10 percent.
And that means that, yes, you're going to have some losing months, but most of the time, the vast majority of your trades and your potential winning months are going to be above zero. Meaning that they're going to be profitable on some level.
Now, let's take the opposite example here, and let's say that we're shooting for a 50 percent return per year. Now think about this, at 50 percent return per year, means you're taking on at least five times more risk, right?
Probably more because it's going to be an exponential risk to earn 50 percent per year. You're going to try to make a ton of money, but you're going to have to increase the amount of risk that you're making per trade.
So again, you start off with that same account balance at zero with not making any money. The first month, maybe you make 10 percent. The next month, maybe you lose 10. And the next month, you lose 20.
And then the next month you make 10, right? So now you can start to see that your account balance, although you may get to 50 percent eventually, the fluctuations and the volatility in your account trying to hit that 50 percent target is going to be much greater.
And the problem that I have with shooting for a target that's too high, even though I think you can do a 50 percent return, is that, when the times when you lose money, are you going to be the type of person that's willing to hold through those really tough times where you could potentially lose 30, 40, 50 percent of your account over the course of a month or two months or a year, and then try to trade back from that time period?
And I don't think that many people would do it. I don't even think that many people want to do that. Because honestly, think about it, if you invested, say 10,000 dollars, and over the next six months, you could lose half of that, would you be willing to continue to stay on the track trying to hit that 50 percent target?
And I doubt many of you actually would, even though some of you might right now during this video say, "sure, I'll stay on track to hit that 50 percent target." But I doubt that's the case.
In my personal opinion, I shoot for around 1520 percent. That's where we've historically landed. We've actually landed around 18 percent, but we shoot for anywhere between 15 and 20 percent return, and again, I'll show you how we come up with those numbers here in a second.
Because for me, I feel like that's a good amount of volatility in my account, it definitely moves, and yeah I have the occasional month where I lose a little bit of money, but most of my months are higher. Meaning most of my months are profitable, and I'd much rather see a consistent, conservative income stream.
So, the question from her naturally becomes, well we know that we can sell options at any probability level that we want. So we can sell options at a 60 percent level, an 80 percent level, 50, what is the optimal level for return and risk or margin use?
What we've done before, is just go back and look at one IWM naked put. Now we did this a little while ago, and this is not the "one size fits all" example here, but it does prove the point that we're trying to make about the optimal, or what we believe to be the optimal, probability level for selling options.
What you can see here on this chart is that there's different probability levels that we've looked at for some naked IWM trades. So 60, 70, 80, and 90 percent chance of success. So the likelihood that you win on the trade.
Now, naturally, with a 60 percent chance of success, you make the most amount of money if you're right. Because, again, the market's fair. So lower probability of success, higher potential profit or credit.
Same this starts to happen as you go further out in probability. The amount of credit that you make as you go further out declines because as you increase your chance of success, you decrease the total potential profit that you make, okay?
So now it becomes, where do we find that optimal difference? Well, the difference in credit between 60 and 70, in this case, was almost a 30 percent difference in credit. The difference between 60 here ... I'm sorry, the difference between 166 here and 112 here was, again, another 32 percent difference.
And now the difference between 112 and 47 was a 58 percent difference. Okay, so you can start to see that your credit starts going down exponentially. First, it goes down 29 percent, then the next 10 percent jumpup goes down 32. And then the next 10 percent jumpup, it goes down almost 60 percent. Okay?
So you do have a point at which it doesn't make sense to increase your potential profit, or your probability of profit, because your money that you could make is going down exponentially. Now the margin that's required is here.
And you can see the margin that is required for each trade goes down as well because the brokers know that as you sell further out options, as you're increasing your chance of success, you don't have to cover as much margin because there's not as much risk in the trade.
Now if we look at just the return on capital, which is the credit divided by the margin, you can see that the return on capital as well goes down. So it's all making sense. The increased probability of success, lower total credit, lower margin, lower return on capital.
But what's interesting here is that the difference between the return on capital for the first two, so jumping from 60 percent to 70 percent, was a 17 percent difference in return on capital. Meaning the difference between 11 and 968 here.
The next 10 percent jump level, so from 70 to 80 percent, was a 19 percent drop in return on capital. And then you can see, again, just like what happened with the difference in credit, once we jump from 80 percent winners to 90 percent winners, the return on capital dropped a dramatic 41 percent. Okay?
So what's really important here to understand is that there is a point at which having 90 percent winning trades is taking on potentially too much risk and not getting enough credit, or taking in enough credit to compensate you for that risk. And you can see that breakeven point starts somewhere around 80 and starts to head out towards 90.
So, for the sake of what we do here at Option Alpha, we basically base most of our pricing on a one standard deviation probability move. And we think that gives us the most optimal use of capital.
Okay, that's around a 70 percent chance of success when you start building out trades. So whether you're doing a onesided trade or whether you're doing an iron condor, or a butterfly, you want to try to build those trades to have a 70 percent chance of success.
And again, that's what we've found looking at multiple pricing scenarios over the last eight years that gives you the best use of capital, the best return, and doesn't sacrifice your winrate too much. And definitely not anything under 60 percent. That's at least where we stand.
Now, as we start to transition to figure out how much money we need to be making on a yearly basis, what we do is we break that down into basically two components. So we basically break down how much allocation your overall portfolio is invested in options.
Now we have here different allocations just to kind of prove the point. But let's say, for example, that of all of the money that you have available to trade, five percent over the course of the year is invested just in options trading.
So if you have 100,000 dollars, that would be 5,000 dollars of your 100,000 dollars is invested in options trading. Okay? If you have a 10 percent allocation, that'd be 10,000 dollars of your 100,000 dollars, etc. etc. etc.
Now the reason that we cap that at 50 is that we never suggest really that you go over 50 or 60 percent of your total account balance. That means that if you've got 100,000 dollars, we never suggest that you invest more than say 50 or 60 thousand dollars in options trading.
You just don't need to invest the full 100,000 dollars to make a return that's extremely great for the full portfolio. Okay? We feel like you can use options wisely, use the leverage that options give you on that 50 to 60 thousand dollars and still make a great return on the overall 100,000 dollar portfolio, okay?
Now the other thing that we look at is we look at return on capital per day. So again, we'll go through a bunch of examples here, but there's different return on capital levels per day. And so this is really what you want to start thinking about is where do you want to target your return on capital.
Again, the more risk that you take on, or the higher the return on capital that you shoot for, you just have to understand that you may not win as often, and you may be taking on more risk, which means more volatility in your account like we talked about before.
But for example, let's say that we want to generate 10 percent, or around 10 percent return on our overall portfolio. So this is that whole hundred thousand dollar portfolio. Well, we would need to earn about 0.3 percent return on capital per day for the entire year on just 10 percent of our account.
So again, if we just invested 10,000 dollars of our 100,000 dollar portfolio, just that 10,000 dollars and that 10,000 dollars was earning 0.3 percent per day for the entire year, then at the end of the year, our overall portfolio would make 10.9 percent. Okay?
So that means we still left 90,000 dollars in cash. And now you probably can start to see why options, in my opinion, are extremely profitable and less risky than trying to invest 100,000 dollars in stock and hoping you make 10 percent. Investing the entire amount of money in the market.
So this gives you a really good basis for where you want to start trading and basically targeting your probabilities and your returns. Again, we're going to go through an example here in a second.
And in my opinion, I usually like to focus on things that earn less than 0.25 percent per day because I want to be at a higher probability of profit level, meaning that I want to have a higher chance of success on the trades that I make.
So I keep my win rate high. So I don't really focus on something that has a insanely high return on capital per day, but I'm also allocating a lot of my money to the market every since month and every single week.
So usually, we've got about 30 to 25 percent of our portfolio allocated at any given time. And so obviously that gives us kind of the numbers that we're shooting for. So somewhere around 15 to 18, 20 percent per year is what we're targeting.
So in this example today, I want to go through a bunch of different pricing scenarios for IWN. Now it's really important as we go through this that you really take the time to understand this because this is going to be an integral part in how successful you become trading options.
If you don't understand the math behind how we get to whatever percentage return we're targeting, then you really won't know, or won't have the confidence to continue to make trades over and over again even if you have a bad month or two bad trades or three bad trades.
The numbers always work out to be profitable, it's just a matter of making small trades and making them often enough so that these number work out. Okay?
So in this example here, we just took a screen shot just the other day of IWM. This is the Russel ETF, so insanely liquid, great options, very tight markets. And at the time that we took this screen shot, the IWM was trading at 106.92.
So basically 107. The May contracts at the time, which were 57 days away, that's that 57 right there, 57 days away, basically have these options pricings across the board. So these are the puts on the right side, and then we have the calls on the left side.
Now what we did is we basically said okay, let's start with just naked selling a 102 strike put option down below the market. Okay, so again stock was trading at about 107 and we're going to naked sell a 102 put option down below the market.
Those put options were trading for about 173 each. And you can see that the probability of those options being in the money, where the probability of those options losing based on that strike price was about 31.47. Okay, so the likelihood that you actually made money on this trade was about 70 percent.
And the reason that I say about 70 percent is because actually the breakeven point, since we collected a dollar 73, was actually closer to around 100. But just for the sake of argument, making our numbers simple and the math simple for us, we are going to say that there's about a 30 percent chance that you lost money, about a 70 percent chance that you made money.
And again, that's based on probabilities, historical pricing, everything that we know about IWM moves, any move it's made in the past, the magnitude, the timeline, for the next 57 days, there's only a 30 percent chance that it closes below 102.
So that's a high probability trade that we can make. So when we bring up this order dialog box that confirms everything for the order, we can see here that the max profit on this trade is the 172 credit that we could take in.
Again, this is selling the May 102 puts at 172 dollars each. Now the margin required for just one of these contracts is 16.45. So that's the margin right there that's required to get into one of those contacts, or the risk that you have to put up.
So if we take 172 and we divide it by 16.45, we get an initial 10.45 percent return on our investment. So if this trade works out, then we make 10.45 percent.
But we know that this trade is not going to work out 100 percent of the time. So we have to take our 10.45 percent ROI and times it by the probability of success that this trade has, which is 70 percent.
So only 70 percent of the time are we going to look at making somewhere around 10.45. So our effective return after we factor in the probability of success is 7.31 percent, again after we factor in that 70 percent chance of success. Okay?
So now we have our return on capital after we have calculated the return or the probability of success. We now divide that number by 57, that's the number of days left in the contract expiration period.
So again, if we go up here, you can see that 57 is right here, that's the number of days left. And that gives us our return on capital per day. So we're going to expect to make about 0.12 percent return on capital per day for the 57 days that we're in this trade.
Now if we assume, again, this is the assumption that we make trades like this all the time, all year, which is very easy to do, so it's not hard to do a lot of trades like these ...
if we assume that we make this type of trade every single day, all year, or have a trade on like this that makes 0.12 percent return on capital per day, all year long, and we only invest 25 percent of our accounts ...
Okay so again, this is where we get back to what we talked about earlier. We're leaving 75 percent of our account just in cash in this example. So you can increase your investment, you can decrease it, whatever you want to do.
But in this case, we're just assuming 25 percent of our account is invested in something like this. Okay, so we'll scale up the number of contracts, or whatever we need to do to get to 25 percent of our account invested in a trade like this.
So we take the 0.12 percent return on capital per day times 365 days a year, but we're only making that on 25 percent of our account that's invested, and that gives us an 11.71 percent annual return, okay?
Hopefully I didn't lose you. If I did, go back, rewind this video, go through it again, we'll go through another example here, okay?
And again, the reality is that is a pretty powerful return when you think about the fact that you're only investing 25 percent of your account. So if you've got a 100,000 dollar account, 75,000 dollars of your money is sitting in cash, not at risk at all, probably earning a little bit of interest from your broker.
And the other 25,000 dollars is actually earning a much higher return on capital that compensates for the other 75 percent that's sitting in cash. So again, this is why I love options trading.
Because, although we don't want to ever invest that 100,000 dollars, we still want to be smart and conservative with our money, we can still have a lot of money left over. We don't have to risk way too much money investing in stocks and trying to earn a 10 percent return investing that 100,000 dollars. Okay?
So now, let's look at a different example. So, in this case, let's go down and look at a trade that has an even higher chance of success. And just to show you how these numbers work out again like we had talked about before, risk and reward are efficient in the market.
So you can't get something for free without giving up something. So let's look at selling just the 96 strike put options. Now obviously, these are much lower than the 102 options.
And you can see the likelihood of these options going in the money is about 15 percent. So 15.81, I'm just rounding down just so that we can use simple numbers and simple math here. So about 15 percent chance that this thing goes in the money.
So about an 85 percent chance that it never hits the 96 strike. And again, that's logical, that makes sense. Because there's about a 30 percent chance it hits the 102, about a 15 percent chance that it hits the 96. Okay, because that's a much lower strike.
So if we were to sell those 96 strike put options, we could collect a profit of about 77 dollars. Now you'll notice our margin is lower as well because this is a less risky trade.
The brokers recognize that. They realize that you have aa higher probability of success, so they carry less margin to keep this trade. Where you're buying power effect is dramatically less.
Now we have a return on capital on the raw basis, or kind of the front basis, of 7.39 percent. Now, this is different that our 10.45 percent that we had for the initial or original trade. So now, again, we do the same type of calculations that we did before.
We take that 7.39 percent return on capital, we times it by the likelihood that we're going to win and make that money of 85 percent. And that gets us kind of an after return and probability of 6.28 percent.
And again, we take this number, divide it by the number of days that we're going to be invested in this, which is 57 days. So we're basically looking at a 0.11 percent return on capital per day for a trade like this.
Now again, we take that return on capital, assume, and yes this is an assumption, that we make the same type of trade over and over again all year long. We have the same amount of money invested in the same type of trade all year long.
And again, it's very easy to find these types of trades, they're not hard to find. So we assume that we have an 11 percent return ... a 0.11 percent return on capital per day times 365 days a year.
But we're only making that money on 25 percent of our account that's invested. Again, we've got 75 percent sitting in cash. That gives us a 10.06 percent return annually. Okay?
So very easy to see how you can just make a couple of simple trades with minimal risk, without investing 100,000 dollars of your money and still generate a very decent return trading options. And again, obviously, we're looking at a 10 to 12 percent return.
So what you should have noticed is that obviously, the market is efficient. When your probability of success went up from 70 to 85 percent, your annual return went down accordingly. Went from 12.71 down to ... I'm sorry, 11.71 down to 10.06.
Now let's look at something a little bit different. So instead of looking at just a naked trade, which is just selling the 102's or selling the 96, let's actually look at something different, and that is a credit put spread.
So let's look at selling the 102's and then buying the 100 strike puts and creating a put spread. Now, again this is going to have about the same probability of success as the selling of the 102's because it's still ... you would still lose if the market goes down below 102. That's no different. But now you have limited risk by doing this credit put spread.
So again, in this example, we're selling the 102's, we're buying the 100 strike puts to create a vertical credit put spread. We cap our potential profit at this point to just 40 dollars.
But notice that our risk is dramatically reduced from thousands of dollars, potentially, to 162 dollars per spread that we're trading. Now on the outside, this is a higher return on capital. So 40 divided by 162, we're making 24.5 percent return on capital.
Now if we continue on with this example, again, taking that 24.5 percent ROI times the likelihood that we actually win, which is 70 percent, that gives us kind of that after probability being factored in return of 17.15 percent, divided by the number of days that we're in the trade, about 57, and so we're looking at basically a 0.3 percent return on capital per day that we're investing in this particular security.
Now again, we take this and we say assume that we make this type of credit spread trade time and time and time again over the entire year. we're looking at a 30 percent return ... a 0.3 percent return on capital per day, times 365 days in the year. But we're only making that money on 25 percent invested. That leaves us with a 27.5 percent annual return. Okay?
And again, if we go back up to our chart that we had before, if you look at basically a 0.3 percent return on capital per day with that 25 percent return ... or 25 percent of your account actually invested, you come up with virtually the same 27 percent return annually on the entire amount of money that you have invested.
So again, you can see how this works out well doing the credit spread versus doing the short put. But don't mistake this credit spread automatically as being a better trade necessarily.
Yes, you did increase your ROI and your annual return, but you gave up 76 percent of your total dollar profit. Now, remember, higher ROI, you had less risk in the trade, but you gave up something. And in this case, you made only 40 dollars versus making 172 dollars.
Now It's funny, because I'll often ask people if they want the highest ROI or the highest dollar profit. And there is a difference. Now there's no right answer here, but it is important to understand the tradeoffs.
So you can absolutely go after more of the credit spreads, scale up, sell more of the credit spreads, or you can do more of the naked positions, right? And do less contracts.
You do more credit spreads, you have a lower dollar profit per trade, higher commission costs, because you'll probably have to do 10 or 20 of those to make up for some of the sure premium naked positions.
Again, it's a tradeoff that you have to make and have to decide on. But I'm just showing you that it is entirely possible to make a very decent return trading options with a small amount of your money invested, even if you're doing naked positions or if you're doing a credit spread trade, which anybody can do.
I mean, the reality is, I could go back to this example, anybody that's out there that's starting out can take a trade that has 162 dollars of risk. That is a very very low risk threshold. You can take this trade if you've got an account of 5,000 dollars or 3,000 dollars.
That's a trade that you can take. And the same thing is, you can just scale up that trade or do some other trades, widen out the strikes. There's a million different things that you can do to increase your profit.
You can take on a little bit more risk, sell less contracts, okay. So there's no right answer here as to what is necessarily better, you just have to understand that the market is fair and efficient.
So if you take on more risk, you could potentially make more money, but you sacrifice probability of profit, etc., etc. etc. So I always say, you will hit what you're aiming for.
We highly suggest you pick one probability target, say 70 percent, and place all of your sure premium trades at that same probability level over and over again. Okay?
As a guidepost, if you target trades around 70 percent, you should hit anywhere between 15 and 20 percent per year, depending on the types of trades you're doing, how much money you're investing in the market, etc., etc. Okay?
We target around the 70 percent chance of success for every single trade that we do on the sure premium side. That's just where we hang out. That's our target that we're always going after so that we're consistently shooting at the same probability level.
And again, that helps build confidence; it helps build consistency, and persistence in your trading. I think it's really important that you take the time now to think hard about where you want to be in your trading.
I would highly suggest that you avoid trying to go after the 92 percent, the even 50 percent return per year type trades until you get really comfortable with an options trading system.
Start small. You can always scale up. You can always increase your risk. But if you go for the big home run shot in the beginning, there is a good chance that you have a really bad trade because you took on too much risk and you can't ever recover from that.
Or it takes you a long time to recover from that. Okay? So I'm not saying that you can't do that, I'm not saying that guys out there can't make a lot of money trading options, I'm just saying know what type of risk you're going to be taking on to get to that level.
So, as always, hope you guys enjoyed this video. This was a fun one for me to do. Hopefully, it was something different that you've never seen before. I'd love to know your comments, your feedback.
If you love this video, please share it online. Send it to a friend, a coworker, or a family member, help us spread the word about what we're trying to do here at Option Alpha. Until next time, happy trading.
eBook Download
The "Ultimate" Options Guide
The stepbystep guide on how to set up each of the top 18+ options strategies we trade to generate monthly income. Read the whole strategy guide in less than 30 mins and have it forever to reference.
Join More Than 47,345 Members
Membership is always free & you can upgrade anytime to unlock our live trades.