Model Assumptions & Formulae

Cash Secured Puts and Covered Calls

These are the current model assumptions on which cash secured puts and covered calls examined by The Wheel Screener are pre-filtered down to the contracts made available here on The Wheel Screener.

    Formulae
    • Collateral required - For cash secured puts, Collateral Required = 100 * Strike Price of Put. For covered calls, Collateral Required = 100 * Current Share Price. (The true collateral is simply 100 shares of the underlying, but in an instantaneous notion is equivalent to 100 * the current share price.)
    • Estimated Probability of Profit = 1 - Absolute Value of Delta. This is a first-order approximation based on the Black-Scholes model. It will be improved soon.
    Screener-Wide Formulae

    These formulae apply to all contract strategies across The Wheel Screener.

    • Estimated Return = Estimated Credit / Collateral Required. Simply the estimated credit that will be received divided by the estimated collateral required. This percentage could also be consider a form of the reward vs. risk ratio.
    • Estimated Losses if Assigned = Collateral Required * 0.01 (or 1% of collateral). The Wheel Screener assumes a maximum loss of 1% of your collateral if assigned. This assumes you would sell back the assigned shares to market immediately. The 1% accounts for small price fluctuations in the market share price in the time it takes to be assigned and sell them back to market. This can be much greater in volatile stocks for example if you are assigned on a day where the underlying gaps down (for CSPs) or up (for CCs) on the day you are assigned.
    • Reward to Risk Ratio = Estimated Credit / Estimated Losses if Assigned. Simply the estimated max credit that will be received divided by the estimated max losses.
    • Market Efficiency Metric - Estimated Return + Estimated Probability of Profit. If this metric is above or below 100%, it means there is some externality causing an inefficiency in the option pricing. When it is above 100%, typically the externality when it is is some form of implied volatility. When it is below 100%, the option is likely priced asymetrically (the reward to risk ratios are poorly configured.)
    • Annualized Return (Simple) - Estimated Return*(365 / Days To Expiration). This is a simple annualized return equation. Note that it assumes the trade is an 100% winner - that is, you get ALL the credit or premium when you originally sell it, and the option expires worthless. Also, it does not consider compounding of returns. See the complex calculation below.
    • Annualized Return (Complex) - (1 + Estimated Return)^(52 / (Days To Expiration / 7)) - 1. This is a more complex annualized return, based on your ability to do a trade on a weekly basis, and includes the effects of compounded returns. This formula also assumes the trade is an 100% winner - that is, you get ALL the credit or premium when you originally sell it, and the option expires worthless. Also note this calculation only really applies to options which you would always buy exactly the same number of days before expiration.
    • Kelly Criterion - Estimated Probability of Profit - ((1 - Estimated Probability of Profit) / Reward to Risk Ratio) The Kelly Criterion tells you the max amount of your portfolio, as a percentage, that you should place on a trade. Typically what is returned by the formula is treated as the maximum amount of what should be placed. Most disciplined traders take an even more conservative value, dividing this number by 4 or even more as a sort of 'reduced Kelly Criterion'.
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