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Archive for June 23rd, 2013

Calculating ROIC – Follow-up

Posted by mounddweller on June 23, 2013

Fellow Traders,

This post is in response to the comment I received back from Esa regarding more specific questions about how to calculate the total amount of capital employed during a reporting period.  Esa has follow-up questions regarding specific trades.  A visual representation of the trades is shown below.

BLOG - ESA's Trades

In looking at this graphic and performing a few calculations I arrived at the following key performance indicators (KPIs) for the month of May:

Minimum Capital: $0.00 (Esa did not have any open trades during the first 5 days in May)

Maximum Capital: $30,250.00 (Esa had 5 open trades the last two days of the month ($3600, $7250, $4150, $9750, and $5500))

Average Capital: $8,982.26.  This can be calculated in one of two ways.

(1) Add the total amount of capital required for each of the 31 days during the month of May then divide this sum by 31.    [((0+0+0+0+0+3600+3600+3600+3600+7750…)/31)] or,

(2) Calculate the average capital required for each trade and then sum the 7 results.  [((WFC=3600 x (26/31)) + ((KO#1=4150 x (10/31)) +…]

Now, let’s look at Esa’s other question…

“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. “

I say, it depends.  If the WFC and MSI trades are naked puts (NP) then I put them in my May trades.  If they are covered calls (CC) then I would wait and include them in my June results.  Why, you ask?  Well, for me it’s all about calculating cash flow and ROIC.  If they are NPs then I know the total amount of cash flow I’ll receive right away.  With CCs it depends on whether the call finishes ITM and I’m called away or OTM and I’m left holding the stock and needing to enter another CC trade the following month.   Another approach would be to include the CC premium in the month it was received and any subsequent gain/loss on the corresponding stock position in the month the position was finally closed.  However, this would increase the level of complexity required in keeping track of your trades and their results.

So, for simplicity’s sake let’s assume all 7 of Esa’s trades were NPs.  Let’s further assume each earned a 1% ROIC net of all fees and expenses.  What would Esa’s total return on invested capital be for the month of May?  What would be the annualized result?

 

Esa’s total return on invested capital would be 4.30%.  How did I calculate this?  Well I added the individual 1% cash flows received from each of the NP trades initiated in May (i.e, $36 + $41.50 + $42.50 +…).  This equals $386.50.  I then divide this sum by the average amount of capital used during the month of May.  Recall, this was $8,982.26.   Annualized the return would be 50.66%.   This is computed as follows: [(0.043 x (365 / 31))].

I hope my explanation is easy to understand.  If not, let me know where I failed to clearly communicate.

 

Regards,

Troy

 

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