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Chapter 3. Options in Context > Return Calculations—Seeking Valid Comparisons

Return Calculations—Seeking Valid Comparisons

Margin limitations certainly inhibit investor activity if only a small amount of capital is available. An equally complex problem is the calculation of returns from option activity. In attempting to measure and compare option trades—whether employing timing strategies or the safer and more reliable covered call—you face a problem. How do you measure your profits? Consider the problem of the covered call trade. You have three possible outcomes: exercise, expiration, or close of the position. In the first instance, you combine a capital gain with profits from selling a covered call; in the second two, you realize a level of profit, but you still own the stock. So, comparing possible returns cannot be done on a like-kind basis.

We have to look at potential returns as possible scenarios and judge the covered call if any of the three outcomes occur. Comparative return analysis is a wise move, and as a conservative investor, you want to know the best-case and worst-case range of outcomes before proceeding; but remember that the time a position is open and the actual outcome make comparisons elusive. The purpose in return analysis has to be to judge the strategy in all of its outcome permutations, and not to arrive at comparable outcomes.


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