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Options Profit And Loss - How to Calculate Profit, Loss and Break Even For Option Traders

As an options trader, calculating profits and establishing break-even points are an important part of managing your all your trades.

 
PRLog - Nov. 12, 2010 - Options Profit And Loss

As an options trader, calculating profits and establishing break-even points are an important part of managing your all your trades. You need to have a basic knowledge of the key concepts, so that you not only know when you are actually making a profit, but also so that you can be sure that newsletter providers are not leading you up the garden path.

It is important to know that the different option trading strategies have different calculations. You need to consider two steps: what is your break even point (so that you know where your profit starts to kick in); and what your profit will be as the trade progresses. Hopefully, you won't make any losses, but if you do, you need to have a realistic idea of how much you have lost!

To start at the simplest level, consider how you would calculate your break even 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 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, when you buy and when you sell. The above trade would therefore work out that your break even point for the entire trade is $2503, and your ultimate profit if the stock went up to $28 would be 11.88%.

So, what's the big deal? Your trade cost $3, or you dropped 0.12%. Small change! Well, when trading options, it is a big deal, because options are expensive to trade in the first place, and as soon as you start working with combination's 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. Get your Options Profit And Loss @ http://slackers-trading3.blogspot.com/?tid=prlog061110 and be Successful forever!

How do you calculate break even and profit when option trading?

   * When buying calls and puts: If, for example, you buy one call option for a stock at a cost of $250. After a few days, your trade has gone well, and you the option is valued at $500, so you sell, thinking that you have made 100% profit. Not necessarily! The broker's fee for this trade could be $12.95, or even $15 for some brokers. So, if you account for broker fees both when you buy and sell, the cost of your trade could be $25.90. This means that your break even is now $275.90. In other words, the value of your option must increase by just over 10% before you even start to make a profit! That is acceptable, because most traders aim for at least 50% and usually 100% growth in their trade. However, if you option price has doubled, as in this example, you have in reality made a true profit of something closer to 80%.
   * When Selling Options: To calculate your profit when selling an option (like a naked put), 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). Therefore, if you sell a Put, you are immediately credited with the cost of the put. From this, you can calculate your basic ROM. If you let the option expire, you only pay a broker's commission ONCE, and you must subtract this from your income from the sale in order to find your true profit. To calculate your breakeven, you need to remember that you have been 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 above example was for selling a single option. Selling credit spreads involves trading not one, but two options: you sell one option and buy another. If your broker charges per trade, then your profits and break evens are calculated exactly as if your were selling single options (look at ROM, not ROI). If you are charged per option unit, then you must double your cost of trade, and if you let the spread expire, then you only pay one fee. When you buy back the spread, and sell another, you pay a fee for each transaction. For a butterfly or Iron Condor trade, you are trading four options at one time, and so it gets quite expensive.

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. Get your Options Profit And Loss @ http://slackers-trading3.blogspot.com/?tid=prlog061110 and be Successful forever!

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Always dream of being Rich? Never able to make a Consistent Profit through trading?
Get your Options Profit And Loss @ http://slackers-trading3.blogspot.com/?tid=prlog061110 and be Successful forever!

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