The Money Tree

Safely Generating Income in Retirement

Calculating Return on Invested Capital (ROIC)

Posted by mounddweller on June 22, 2013

Fellow Traders,

I recently received a comment and question on my May 2013 Results posting.  Esa, from Finland, wanted to know how I would calculate my Return on Invested Capital (ROIC) and determine the total amount of capital used when I held multiple positions during the course of a month.  Below I provide ROIC and total amount of capital used calculations for three different scenarios.

BLOG - ROIC calendar

In Scenario #1 I am placing three different trades on the same day.  Let’s assume the following:

(1) each trade will be held for 30 days,

(2) each trade requires $5,000 in capital,

(3) each trade generates a 1% ROIC net of all fees and expenses.

What is the total capital used?  In this scenario the answer is easy…$15,000.  I had three trades, each requiring $5,000 in capital.  The ROIC calculation in this scenario is also easy.  Each trade had an ROIC of 1% so my total ROIC must also be 1%.  My annualized ROIC is 12.17%.  This is calculated as follows:  [((0.01 x 365) / 30)].

Scenario #2 is a bit trickier.  In this scenario on the first day I place a trade requiring $5,000 in capital.  Like in the previous scenario it is held for a period of 30 days.  10 days later I place a second trade.  It too requires $5,000 in capital.  However, I only have this trade open 20 days.  10 days later I place my 3rd trade.  I hold it for 10 days and it also requires $5,000 in capital.  Like before each trade generates a 1% ROIC net of all fees and expenses.

What is the total capital used?  The answer is $10,000.  Here’s how I arrived at that number…[((5000*(30/30)+(5000*(20/30))+(5000*(10/30))))].  Trade D was held for 30 days, Trade E was held for 20 days, and Trade  F was held for 10 days.  Each required $5,000 in capital.  What was my ROIC?  It was 1.5%.  Each trade generated a return of $50.  Thus, to calculate the combined ROIC we simply divide the $150 earned by the $10,000 in average capital required to place the trades.  The annualized ROIC is calculated the same way as in Scenario #1.  [((0.015 x 365) / 30)].

Scenario #3  assumes three equal, consecutive trades are made.  Trade G is closed out before Trade H is entered.  Likewise, Trade H is closed out before Trade I is entered.  Each trade lasts 10 days.  Each trade requires $5,000 in capital.  As before each trade generates a 1% ROIC.

What is the total capital used?  The answer is $5,000.  I used the same capital 3 times during the month.  The ROIC is 3%, one percent for each of the three trades.  The annualized ROIC is 36.5%.  It is calculated as follows: [((0.03 x 365) / 30)].

So there you have it.  If anyone has another way of calculating returns please let me know.

Regards,

Troy

 

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6 Responses to “Calculating Return on Invested Capital (ROIC)”

  1. Esa said

    Dear Troy,

    firstly many thanks for your good and quick reply! Surely enough you get at least my approval for using the “world renowned money tree blogger” as your slogan. : )

    Even though your reply covered several different scenarios I can’t help asking for advice on even more specific situations regarding this issue. I’ll take my trades in May as an example. I sold 7 puts in May as follows. First is ticker, then trade date, expiration date, number of days and tied capital.

    WFC 6.5.2013 – 7.6.2013, 32d, $3 600,00
    KO 9.5.2013 – 18.5.2013, 9d, $4 150,00
    KO 20.5.2013 – 24.5.2013, 4d, $4 250,00
    AXP 23.5.2013 – 31.5.2013, 8d, $7 250,00
    KO 28.5.2013 – 31.5.2013, 3d, $4 150,00
    MCD 29.5.2013 – 31.5.2013, 2d, $9 750,00
    MSI 30.5.2013 – 21.6.2013, 22d, $5 500,00

    First of all, am I wrong when I say that you would put WFC and MSI as June’s trades because they expire in June (unless for example bought back in May)? Do you see a problem in putting them into May’s figures? Obviously this might be different with puts and calls as the latter’s profit depends usually on whether the option is called or not.

    Secondly, how much do you get as the total capital tied for these trades in May? And if possible it’d be great to see the calculations on how you ended up with the figure like you showed in your post. I’m not sure whether it’s an appropriate way to calculate but I ended up with $13 333.33 (counting all the trades in May’s figure) when I used the method you provide in your second scenario. So is that in your opinion the way to go in this kind of case or is there a better formula/idea?

    I appreciate your replies a lot and thank you very much for all your valuable help!

    Best regards,
    Esa

  2. Ray Smith said

    Dear Troy,

    Suppose you have $250000 in stocks and use margin (available from the existing stock holdings) to sell puts. Each put selling transaction reduces margin but no cash is involved. What’s the ROIC of the transactions in your example? From the portfolio point of view, what’s the return of the portfolio (i.e., $250000) contributed by margin put selling transactions?

    Regards,
    Ray

    • mounddweller said

      Ray,

      Thanks for reading my blog and for posting such a good question. Unfortunately, I don’t know the answer. I only do option trading in my retirement accounts so I have never had to give much consideration to the impacts of using margin on calculating returns.

      For tracking purposes I would just calculate it the same way as with cash secured puts. That way you’re comparing apples to apples when measuring your success against other trades or traders.

      For calculating the overall return of your portfolio in a given period I would simply take the ending balance subtract the beginning balance and divide that result by the beginning balance.

      Regards,
      Troy

  3. Ray — IMO, margin makes no difference in the calculation. It’s return versus capital at risk. All margin does is allow you to put more capital at risk.

    • mounddweller said

      Randy,

      I didn’t realize you were a reader of my blog. I’m flattered! Truly appreciate your SMF tool and all of the effort you put into it.

      Regards,
      Troy

    • Martin said

      I agree. Margin is just added capital at risk which you added not from your own pocket, so to your gain or loss you just need to add an interest paid to the broker, all other stays as is.

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