What are suitable monthly P&L targets for a theta-positive option portfolio that are generally delta neutral? For the smooth option portfolio, the monthly profit target is 10% of maximum risk traded: ROR = 10%, with the average profit of 7.5%. The monthly loss target is limited to 10% to 15% with an average of 10.25%.

The smooth portfolio usually has expiration probability of 25% in either side and potential max ROR of 35% to 40% for its high probability trades. With planned adjustments, the expected win for each year is 9 months and loss is 3 months. So yearly profit on risk is 9x7.5 - 3x10.25 = 36.75%.

Note the annual ROR of 36.75% is based on risks only, not a portfolio return. The portfolio return should be 36.75% times the percentage of risks allocated for each months. If the risk allocated is 30% monthly, then the portfolio annual return rate can be around 11% only.

To have better annual return, the monthly loss target should be reduced and losing months should be reduced as well.

At each month, the market volatility is different. After the initial build-up of the portfolio, the expiration profit may be lower if the IV is lower in an up trending market and potential loss may be higher. The targeted profit (at which the positions should be closed) should then be lower as well. It should be 30% or a little higher of the possible expiration profit. If the expiration potential max ROR is 35%, then the targeted ROR is around 35x30 = 10%. If the potential max ROR is lower than 35% due to lower IV or lack of days to expiration date, then the trade does not meet the expectation any more.

Great work. I really enjoy your style. Thanks for sharing

ReplyDelete