Options Glossary

Glossary: Annualized Return on Risk [AROR]

Last Updated: December 27, 2016

Glossary

Annualized Return on Risk [AROR]

What Does Annualized Return on Risk [AROR] Mean in Options Trading?

Annualized Return on Risk is calculated by taking the maximum possible return from the position divided by the notional risk (max loss) that could be realized in the trade.  This return is then annualized for the year.
Note the difference between Return on Risk and Return on Capital.  Return on Risk is generally lower or equal to Return on Capital, as margin requirements are either equal to the notional risk or a portion of the notional risk depending on the spread (setup) type.
Annualizing the Return on Risk enables a fair comparison between trades of different duration.  It is very important to use annualized return vs. total return in your strategy in order to compare various trades of different duration accurately.
For example, if Trade A returned 5% in 4 weeks and Trade B returned 9% in 8 weeks, then Trade A actually has a higher annualized return than Trade B despite Trade B having a higher overall return.
The formula for calculating annualized return can be found below:
annualized-return-on-capital
Trade A = (1+0.05)^(52/4) - 1 = 88% Annualized Return
Trade B = (1+0.09)^(52/8) - 1 = 75% Annualized Return

Synonyms:
Annual Return On Risk

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