The Option Jive segment on August 31, 2016, "TROC (tastylive Return on Capital)" introduced TROC, the tastylive Return on Capital (ROC). The segment explains how when selling premium to capture Theta (time decay) we can predict a rate of return based upon our Theta exposure as a percentage of our net liquidity. Since there are numerous other factors in trading besides Theta we said to expect to capture about 25% of Theta collection which we call our Theta ratio (so we predict that a 60% TROC number will yield a 15% actual return). That was based upon our observations. We promised a study to back up that 25% number. Is that number accurate? How do we create some kind of predictable return based on ROC?
Our study was conducted in the SPY (S&P 500), IWM (Russell 2000) and TLT (20 year Treasury Bonds), three of the largest ETFs. We used data from 2005 to the present. We sold the 1 Standard Deviation (SD) Strangles using the expiration cycle closest to 45 days to expiration (DTE). We found the P/L as a percent of Theta collection (the Theta ratio) for each year and summarized the results.
The results were displayed in a table and a bar graph. The table listed the average, minimum and maximum Theta ratio percentage for each of the SPY, IWM and TLT. The range of the averages was 34% to 14% and the average of all 3 ETFs was 25%. The bar graph used different colors for each ETF and broke down the Theta ratios by year. The varying results are yet another good argument for diversification. A final table reminded viewers about what our 25% rule regarding TROC means for returns.
For more information on Return On Capital (ROC) see:
Strategies For Your IRA from January 27, 2016: "Maximizing Return On Capital"
tasty BITES from May 10, 2016: "Maximizing Potential Return on Capital"
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the valuable takeaways and the results of our study on the percentage of Theta collection one should reasonably expect to capture and how to combine this with the TROC, tastylive Return on Capital to estimate returns.
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