Option Strategy Risk Return Ratios: A Revolutionary New Approach to Optimizing, Adjusting, and Trading Any Option Income Strategy by Brian Johnson

Author:Brian Johnson [Johnson, Brian]
Language: eng
Format: mobi
Publisher: Trading Insights, LLC
Published: 2014-03-29T00:00:00+00:00

Figure 6.4: RTRRR versus Rho

RTRRR versus Theta

The graph in Figure 6.5 below illustrates how Theta affects the RTRRR, holding all other variables and Greeks constant. Theta measures the daily change in the value of an option strategy due to the passage of time. Theta is the explanatory variable and is depicted on the x-axis (horizontal). RTRRR is the dependent variable and is shown on the y-axis (vertical). The upward-sloping curved purple dashed line illustrates the relationship between Theta and the RTRRR, holding all other variables and Greeks constant. The graph of RTRRR versus Theta is analogous to the graph of VTRRR versus Theta in Chapter 5 (Figure 5.5).

The red diamond in Figure 6.5 denotes the starting value for the iron condor strategy on April 18, 2013. Theta represents the source of return for option income strategies, so comparable strategies with higher values of Theta have better (less negative) RTRRRs.

Increases in Theta will improve the RTRRR, but at a decreasing rate because Theta is in the denominator of the risk/return calculation. Increases in Theta will increase the denominator, but the numerator (risk) will always be negative. Therefore, increases in Theta will cause the RTRRR to approach zero, but it will never be positive.

Conversely, decreases in Theta will eventually cause Theta to approach zero. As it does so, the RTRRR will become more and more negative and the rate of change in the RTRRR will continue to increase.

As Theta increases, the RTRRR improves; the amount of risk per unit of return decreases at a decreasing rate. As Theta decreases, the RTRRR deteriorates; the amount of risk per unit of return increases at an increasing rate – assuming all other variables and Greek values remain constant.

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