Calculate Rate on Investment

How Do You Calculate Return on Investment? – ROI

Welcome back, Stock Traders!

As you remember from my last 3 posts, the return on investment or ROI can be much greater for stock options than trading traditional stocks.

How do you calculate your return on investment? This tool is useful not only if you are dealing with the stock market but in other investments as well. Read below to learn how.

Here’s the Formula

Here is the basic formula to figure out your return on investment (ROI):

ROI = (Net Profit / Total Investment) X 100

Net profit = total revenue after deducting all expenses and operating costs

Total investment = total money used to purchase your investment

ROI for Options

Let’s say that Joe is looking to invest in stock options for Z Bread company because he believes the stock price will go up to $10 or more in the next 30 days; Z Bread is currently trading at $100 per share.

Joe buys 2 call contracts of Z Bread that expire May 29th at a strike price of $110 with a premium of $5. Fifteen days later, Z Bread’s market price goes up to $125.

Joe’s current return on investment on this call option if he exercises the option now is:

Net Profit = [(Current Market Price – Strike Price) – Premium Cost] X # of Contracts X 100

$2K = [(125 – 110) – 5] X 2 X 100

Total Investment = (# of contracts X Cost of Premium X 100)

$1K = (2 X 5 X 100)

ROI = (2K / 1K) X 100

ROI = 200%

ROIs for Traditional Trading

Now let’s compare that to traditional trading.

Joe buys 200 shares directly of Z Bread at $100 per share. The stock goes up to $125.

Net Profit = (Current Market Price – Previously Purchased Price) X # of shares

= (125-100) X 200

$5K = 25 X 200

Total Investment = Previously Purchased Price X # of shares

$20K = 100 X 200

ROI = (5K / 20K) X100

ROI = 25%

Life Example

Let’s compare this to more common transactions made by your average person.

Most people view their home as equity or something that will increase in value and make them money over time. Some may even flip houses for money. We will use the traditional example here.

Sara buys a house for $100K in 2005 and sells the same house ten years later for $130K. During this time, she makes routine maintenance repairs to the home that total $5K. Sara also has a 7-year mortgage that she paid $4K in interest on and is now paid off.

What is her return on investment?

ROI = [Net Profit (Gain in Investment – Cost of Investment) / Cost of Investment] X 100

Net Profit = $130K – (All Liabilities + Original Investment Cost)

Net Profit = 130K – (5K + 4K + 100K)

Net Profit = $21K

ROI = ($21K / $100K) X 100

ROI = 0.21 X 100

ROI = 21 %

There are usually more expenses with owning and selling a home so this percentage may be quite lower than some in reality. Many other factors can come into play that affects the return on investment, but I wanted to provide a rough, general reference.

Conclusion

The way the ROI is calculated may vary a bit depending on your trading strategies and use of either buy or selling puts or calls. Return on investment is important to compute to ensure you are making smart choices with your investments for your future. It is also an important step in figuring out your expenses so that you are aware of them and can keep them at a minimum if possible to increase your equity.

We encourage interaction among the site. Please feel free to drop a message below.

6 Replies to “How Do You Calculate Return on Investment? – ROI”

  1. Hi Sonia
    This is a very clear and easy to understand explanation of ROI. I think it is also important to consider the time over which the return was generated.
    Clearly there is a big difference between earning a 40 percent return on a house that you owned for 10 years rather than a 5 percent gain on a stock trade that you executed over a two-week period. And the way to compare them is to turn them into annualized returns.
    It becomes apparent very quickly that the two-week stock trade was more profitable.
    Thanks ane best regards
    Andy

    1. Hi Andy,
      I appreciate your comment. My goal was to try to explain the potential for great returns with stock market equity compared to the normal equity that people are used to..homes for example.

      Best wishes,
      Sonia

  2. Great article!! I don’t know anything about Stock Trading, but I love math, and this article is filled with math, haha. I loved it. I liked how you made sure to describe the use of the term, which helped me understand the article better, and the examples in this article were well explained and put in a simple way that all people can understand. Keep up the great work!!
    -Trinity G.

  3. Hello Sonia,

    Thank you for this very informative post. Your tips on calculating ROI in stock trading is very clear indeed.
    My husband and I just opened an account with X*Trade. We are still not fully grasping how the stock trading works yet but we are willing to learn more. I have bookmarked your site for future reference.

    1. Thanks, Ferra!

      It’s good to get your feet wet. Let me know if you have any questions. I’m happy to help.

      Best regards,
      Sonia

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