Profit Reward and Loss Risk for retail options trading must be managed at 2 related performance levels: Portfolio and Trade Specific.

At the Portfolio level for online options trading, there are 3 types of Targets that need to be set, even before trading.

Maximum return objective: complete achievement of the “ideal” measure. Dream of the “ideal” that stretches you beyond the practical. For example, earn 2-3 times your monthly living expenses with monthly business earnings. This is to stretch your imagination far beyond mediocrity. Even if it fails, it’s possible that you’ll end up with more than your original target.

Minimum return objective: the lowest acceptable measure achievable under most conditions, excluding a catastrophic market event. Use the historical annualized return of the S&P 500 between 10% and 12% (before the 2008 financial pandemic), as the lower acceptable limit. The S&P 500, which is a widely accepted benchmark for trading stocks, is adequate to base the minimum target on, although your portfolio must be profitable: being ahead of the $SPX in negative territory doesn’t count. Below the historical 10%-12% annualized return range is the 3-month T-Bill, currently close to zero. While the T-bill theoretically represents an “absolutely” zero risk investment, even the safest investments will still carry a residual amount of risk no matter how small that risk is. The point is this. You got into options and all that Greek terminology, not to make salads; but to outperform equities as an asset class. If your portfolio return is somewhere between near zero risk and 10% to 12% per year, you are only delaying reaching a pain point that marks failure to understand the benchmark’s ability to control the risks. If your portfolio yields are between 0% and 12% and you plan to continue trading options, you will need to redesign processes within your trading process.

Stop Target Trade: the accumulated losses reach an absolute amount below the Minimum Yield, so it is necessary to stop trading completely for a certain period. 10% discount [(60% x Cash Balance at the start of the year); or Net Liquidating Value]. For ex. For a $50,000 trading account, 10% x (60% x $50,000) = $3,000 of total losses, is the absolute amount to stop trading. Why 10%? Exploiting your self-financed capital is final. There is no rescue package, as a home options trading business does not have access to bank loans; or, shareholder capital to finance your personal operations.

Now, let’s dive into trade-specific performance measures.

Even before calculating the metrics, characteristically what makes a consistently managed portfolio are these traits:

• The biggest loser does not eliminate the biggest winner. The biggest winner should be in multiples of the biggest loser, eg 2-3 times as much.
• Above the largest loss, there are many more winners with win values ​​progressively higher than the value of the largest loser.
• Earnings should gradually increase, depending on the size of your account. If it’s in the tens of thousands, the earnings should steadily climb like a ladder from the low hundreds to the high hundreds; then, go from the highest hundreds to the thousands. If your account is above $100K, earnings should increase from hundreds to thousands. Winnings jumping from hundreds to thousands indicate an over-reliance on gap plays, which don’t help you consistently increase profitable results.

Where can I see this rise feature in a consistently profitable portfolio, with these portfolio measures and trading performance metrics? Follow the link below titled “Consistent Results” to view a retail options trader portfolio model that demonstrates these characteristics.

Moving on to the hard metrics. There are 2 ways to count the return on your trading capital.

• The first way is to take the total profit of the trading account and divide it by the cash balance at the beginning of the year, as of 01/01/YYYY.
• The second way is if you take the total profit of the trading account and divide it by the ongoing net liquidation value.

In both cases, you can subtract the total commission cost from the total profit to get a total net profit number. Then, divide the Total Net Income by the Cash Balance at the Beginning of the Year; o Net Asset Value. Net Liquidation Value is the total value of your trading account, which is equal to Total Cash + Option Value + Stock Value + Commodity Value + Bond Value. The beginning of the year cash balance is simple: it is the money in the account at the beginning of that business year. Cash increases when you are short on securities; but, the cash decreases, as you get long values.

To review your performance, calculate these metrics using your account profit (win) and loss (loss):

• Win/Loss Probability: This is the number of wins divided by the total number of trades. The other way to express this win/loss ratio is to take the number of wins and divide it by the number of losers. the probability of winning/losing; or, Win 1 Loss measures your ACCURACY when selecting trades.
• The average win is equal to the sum of all wins divided by the number of wins.
• The average loss is equal to the sum of all losses divided by the number of losers.

Average Profit divided by Average Loss measures how RESPONSIBLE you are in taking profits and cutting losses.

Combine the accuracy rate with the responsiveness rate to get your performance rate. Yield Ratio = (Probability of Win/Loss) x (Average Win/Average Loss). Always try to keep the performance index above 1.00. Why? The commonly known money management rule is to allocate 2%-5% of (60% x net liquidation value of the account) per trade. What is not commonly practiced is the discipline of sparing +/- 1% in trading allocation between 2% to 5% allocation.

• If you are allocating 2% per option trade, I would increase this by +1% to 3%, if you can keep your yield index above 1.00 for the next month. Thereafter, it would increase by +1% for each month above 1.00, until reaching the upper limit of 5%.
• If you are allocating 2% per option trade, I would reduce it by -1% to bring it down to 1%, if you fail to keep your yield index above 1.00 for the next month. I would keep the per trade allowance at 1% for each month thereafter, until I can set my performance index above 1.00 to increase the per trade allowance again by +1%.

This is how a ladder effect is achieved to increase profits and reduce losses. This raise/lower mechanism is an indispensable tool to reward profits and discipline the risk of losses. It forces you to improve both ACCURACY and RESPONSIVENESS before increasing your position size.

Where can I get more information on portfolio measures and trading performance metrics as part of a total trading system? Follow the link below for 55 hours of online options trading video learning from home.