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Setting Realistic Expectations

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I would like to share with you an email I got few days ago:


I am new to trading options. Matter of fact, I am going to try to make it my new career. I have been reading your strategies and understand some of it. Other parts are a bit confusing to me unless I actually see the steps one-at-a-time and can see what to look for and what the results will be. Can you recommend any books or internet sites where I can learn/practice your strategies? What do you look for in an option? Where do you find the information? I have set aside $10,000 to work with in the beginning in hopes of doubling it at least yearly."

Don't you find it amazing? The guy admits he is new to options, but wants to double the account "at least yearly".

My reply was:
"There is a lot of hype surrounding options trading. Some writers on SA will make you think that doubling your account is an easy task. If it was, we all would be millionaires by now. My advice to you: if you just start options trading, preserving your capital during your first year of trading would be a great achievement"

Here is the problem:
Making money with options is easy. Doing it consistently is much more difficult. People see all the hype and think it is an easy task. To become an engineer you have to study 4 years, and probably another 4 years (at least) to become a good one. Why people expect it to be different in trading?


I see sales pages all the time that show you 200%+ returns on some cheap options they bought. But what they don’t tell you is that those trades happen once in a while and are not consistent. Maybe they did make 200%+ on a trade, but that doesn’t happen all the time and to set your expectations that high would be very ignorant.

Setting realistic expectations is very important. I'm a big fun of the "slow and steady" approach. Aim for many singles instead of few homeruns. Be patient. Be prepared to lose for a while - set your goal as capital preservation instead of doubling your account. Think about the risk first. If you take care of the risk, the profits will come.


Here’s a quick list of some things to consider as you write down your expectations and goals.


1. More traders lose more money than they make. The figures are a little off depending on who you talk to, but it is 80% to 90% (maybe more) who end up losers and leave the business altogether. 

2. Only a small percentage of retail traders are profitable. The numbers get even smaller if you look at a 3-5 year average which measures consistency. Don’t get discouraged, we all fell off the bike before we learned to ride it right? 

3. Paper trade first with a small amount of money. I always recommend members to paper trade everything first. This way you learn how to enter orders, adjust trades, and more importantly learn you’re your mistakes without losing real money. Then when you are ready to invest real money, keep it small. Prove yourself that you can make money with 10k, then increase it to 20k and so on, but do it gradually.

4. You will have losing trades. Too many people quitting after a streak of 4-5 losing trades. Losing money is part of the game, the trick is to keep the losses as small as possible. 

5. Don’t expect to become financially independent. Don’t you think it’s completely unrealistic to expect a small account, say under $5,000, to generate consistent income to replace your regular job? I aim for many singles instead of few home runs.

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I wanted to share with you a feedback from a member who cancelled his membership and provided me the following feedback:

"Hi Kim,

I was very interested in your strategies when I saw the 2011 performance (13.6% average gain). Looking at the 2012 performance I'm not so sure about it (3% average gain). Then once I signed up I watched 7 out of 8 trades lose money. With the high transaction costs of trading options, the 3% average gain doesn't give me much room to cover fees and also fight the bid/ask spreads. I'm going to keep my eye on the performance for a couple more months and then will decide if I want to join back in."

Here is my response:

Thanks for your feedback.

Unfortunately, people concentrate too much on a short term performance. You mentioned 7 out of 8 losers, but the one winner was 15% and sum of the 7 losers 26%. If you go back and include just one more trade, 2 winners out of 9 trades will give you a positive return because the winners are usually much larger than the losers. 3% average gain still give you 40% ROI.

If you followed the discussions on the forum, you would see me mentioning more than once that those trades don't perform as well in a low IV environment. However, even in this environment, the cumulative gain in 2011 is $2,380, based on 1,000 allocation per trade. With IB, you would make around $1,500 net gain while allocating only $1,000 per trade. But if you are patient, you can get results similar to July-August 2011 when IV spikes. Meanwhile we are making nice profits on ICs and calendars. Unlike other services which offer you just few ICs or credit spreads, I offer a total portfolio approach, where different trades balance each other.

What confuses many people is the fact that my performance reporting is extremely conservative. The results of the model portfolio are cashed adjusted and based on 10% allocation. As far as I know, I'm among very few in this industry doing that. The $2,380 gain on $1,000 allocation would be reported by most services as 238% gain. 2011 results would be reported as 1,237% gain.

Setting realistic expectations is very important. If I could consistently make 13.6% per trade, with 15 trades per month and 10% allocation I would be making 20% per month or 240% per year. With those returns, I would be probably retired on Bahamas by now (in fact, I could probably buy the Bahamas). If I can get 4-5% net return per month in this low IV environment (while having about half of the portfolio in cash), I'm not complaining.

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Guest DShaver


I agree with just about everything you said here. I had to learn the hard way, I think I just finished my "education" on a saying "money not earned is easily lost". I was able to make a few good trades the first month trading options spreads seriously and though "Hey I could easily make tens of thousands a year doing this", of course then reality set in and i went on a downward spiral resulting in me being a little lower then what I was when I started. So I wholeheartedly agree with your post here, just wish it didn't cost me 45% of my portfolio to learn my lesson lol. Anyway. I'm glad I joined and am already learning a good bit about options and possible trades.

Thank you.

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We all have to learn our lessons before we can become better traders.

This guy replied to me and said that he will continue to watch my performance. So here is what is going to happen.

The inevitable IV spike happens approximately 1-2 times per year, every year. During those spikes, the earnings trades can easily make 20-25% per month (last August my portfolio increased by 35% in few days). So he sees those gains and rejoins, only to see the next few months going back to the "boring" 3-4% per month (or even suffering some small losses). Then he quits again, just in time to miss the next spike.

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Hopefully not a dumb question. Could you explain in more detail (maybe share the math) by what you mean by "results of the model portfolio are cashed adjusted"? Just trying to do an apples to apples comparison of other websites' performance.


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This is actually an excellent question. Lets take an example of 5 trades per month returning 10% each.

Some services would report it as sum of all trades (50% return). This assumes that you had just one trade open at any given time and allocated 100% of your portfolio to each trade. But some services would report it this way even if they had more than one trade open which would make it simply impossible to allocate 100% to each trade.

The next method is to report an average of all trades. This assumes you allocated 20% per trade, with no cash balance. Some services specifically recommend to keep at least 20% of the portfolio in cash, but report performance based on full allocation. This is simply not realistic and not reproducible.

I report model portfolio performance based on my recommended allocation of 10%. So in the above example, I would report 5% since I allocated 10% per trade and had 10% return per trade. For my portfolio, I have maximum 6 position at any given time, so 40% of the portfolio is in cash, but I still report return on the whole portfolio, not on the maximum invested capital. This reporting is called cash adjusted because it takes the cash reserves into consideration.

Reporting returns this way grossly underestimates the return compared to other services, but I want to be as realistic and transparent as possible. My model portfolio performance reports what was possible with fairly conservative allocation.

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