No. of Recommendations: 1
A better way to consider the whole thing is to create two [fictional] accounts, place $50,000 into each account
A problem with that approach is you end up with slop in the equation that can distort the actual return. E.g., in your buy-write, you have a $50,000 account that is only using $47,000 to buy stock. The extra $3,000 doesn't have anything to do with the ROI on the buy-write trade, but is being included in the calculations anyway. And in your put write account, you have a $50,000 account, but only $46,100 is at risk. In fact, you could open a no-margin, cash-secured account with a $46,100 balance, and sell the $500 put for $39, which would use all your buying power and leave you with a cash balance of $50,000, just enough to be assigned without any margin loan.
So... I prefer using only the capital at risk as the "I" in ROI and calculating it separately for each proposed trade. It's the most accurate way of comparing the performance of one trade idea to another.
In your example, on the buy-write, capital at risk is the $47,000 outlay, minus the premium received of $2,500 in your example, or $44,500. That's the most you can lose. The max gain is the premium plus the rise in stock price up to $500, which is $2,500 (premium) plus $3,000 (stock gain) or $5,500 total. That would put your max ROI on this trade at $5,500/$44,500 = 12.3%.
Using that same approach on the put write, your capital at risk is $50,000, minus the premium received of $3,900, or $46,100. Your max gain is the premium itself plus interest received on the capital at risk that is sitting in the account to support the trade, which is $3,900 plus interest of about $1,937 (assuming 4.2% interest on $46,100 for 10 months), or $5,837. That would translate to an ROI of $5,837/$46,100 = 12.66%. This shows the put write is preferable to the buy-write, using the numbers provided above as inputs, but I don't know if 4.2% is realistic - I know IB is paying around 3.8% these days. If we used that figure, it would bring the interest down to $1,460, the max gain down to 5,360, and the ROI down to 11.6%.
I guess one advantage of buy-writes that's worth noting is that although you have to put out cash, you also don't have to worry about earning interest to fill out your ROI estimates. Interest rates can fall and that can potentially cut into returns quite a bit.
Rob
