MARKR,
JUST GO UP TO MY POST 21 Hours back from here!
Read it carefully!!
Letter by Letter and Word by Word.
NOTE what XIRR Sees and Understands.
Gene
All holdings and some statistics on my Fool profile page
https://discussion.fool.com/u/gdett2/activity (Click Expand)
I am not. Because I don’t know how to do so. Hence the question and the entire point of this post. If I look at that account right now, it says that it has about $150,000 “Cash reserved for options strategies”. And the current value of those options (8 different positions of short puts) is -$30,000. That $150,000 is not a cash flow, and in fact it sits in my account earning interest like any other cash in the account.
And nowhere is it noted how much of that $150,000 is accrued for each of the 8 option positions. I can’t figure out how it relates to exercise amount either, because one of the 8 positions would have an exercise price of $280,000. CBOE says the margin requirement is -
100% of option market value plus 20% of underlying security / index value less out-of- the-money amount, if any, to a minimum for calls of option market value plus 10% of the underlying security / index value, and a minimum for puts of option market value plus 10% of the put’s exercise price.
But still, how is that accounted for as far as return (IRR) is concerned? Should I put those in as “false” cash flows at the start and end? But that’s not enough because the margin amount changes every day as the price of the stock and option change every day. And then, for the complete trade, I would also have to add the interest earned on that sum each day.
Sounds like the right solution. You might simplify by ignoring the daily fluctuations.
The Captain
Does captain calculate irr or some other rate of return for individual options trades?
If yes, how do you do it?
I don’t do puts (short positions). I do calculate IRR but I would have to look at the code (php). I gave up on spreadsheets, too error prone to use as a database.
The Captain
However you sell calls right? Those are short positions.
Do you typically sell covered calls, in which you own stock as collateral against the short call?
Are they? I never thought of them as such. The calls are secured by stocks so there is real cashflow when buying the stock and, unlike cash secured puts, the security is fixed in the sense that there is possible margin call.
A short position is when you sell something you don’t have so you have to borrow it to deliver it. A call is just a promise and a covered call means you already have the goods you offer for sale.
Yes. But the ‘short’ is only nominal, not real, as explained above.
The Captain
Standard nomenclature is buy/sell equals long/short, regardless of the other components of the portfolio.
Portfolio of long stock, short call (with same stock as underlying) is the definition of a covered call which is made up of two positions.
Of course but that is just to standardise the nomenclature.
The Captain
Usually it makes sense to tackle a simpler case first, example below. Other considerations: how much collateral is in your account versus the margin requirement? besides that, it may make sense to calculate returns at the portfolio level versus position level.
For a put, the lower/upper bounds on collateral are (option market value + 10% of strike x 100)/(strike x 100), and these would provide the upper/lower bounds on the corresponding IRR.
Because you absolutely need to be ready to quickly provide the full collateral in case the option moves out of your favor, I think just going with full collateral in the irr calculation is perfectly reasonable.
IRR for cash secured put
Day 0
-100 cash collateral allocated = $1 strike x 100 shares
+5 option premium from sell to open of put on 100 shares, $1 strike
-95 cash flow on day 0
Day 182 (after option moved in your favor, out of the money)
-1 option premium from buy to close of put option
+100 cash collateral unallocated
+2 interest earned on cash collateral
+101 cash flow on day 182
NPV = -95 + 101/(1+irr)^(182/365) = 0
do algebra
irr = (101/95)^(365/182) - 1 = 0.13
then irr is 13% per year
NPV = 0 = (cash flow day 0) + (cash flow day 182) x (discount factor)
where discount factor = 1/(1+irr)^(182/365)
Edit: fixed - sign to + sign