I am trying to find a rule-of-thumb ratio to estimate Annual P&L expectation given a certain average Daily P&L swing for a derivatives market maker. Yes, I can see that it would depend on many things as..which market is traded...skill of the trader...complexity of the book etc.Therefore, this is more of a question of reasonable expectation based on experience...so I would like some input from the desk experience of the derivative experts out there...my particular interest revolves around energy (oil and natural gas) markets but responses from other markets are welcome.Basically, let's say to make $10 million at the end of the year, what kind of daily P&L swings could be expected from a derivatives book? or am I missing some crucial variable(s) to estimate this?Thank you. I appreciate your responses.

I don't have a definitive answer, but here are four things to ponder.(1) US capital requirements for banks cost approximately 30% of daily standard deviation of P&L to maintain. You can't get an exact figure because (a) different instruments are treated differently, some in ways that do not easily relate to standard deviation, (b) it depends on some firmwide factors, not just desk level statistics and (c) it changes with interest rates. Still, I would say a trading desk in a large US commercial bank with annual profit equal to 30% of daily standard deviation of P&L had broken even, before the expenses of running the desk. Actual desks are expected to make much more than this.(2) A zero-capital investment in the S&P500 (buy the index, borrow the money) has returned an average of about 4 daily standard deviations per year since 1925. That does not require any desk expenses.(3) A significant fraction of the total risk of owning a trading desk is the rare catastrohic event. Daily P&L standard deviation over periods that do not include crashes significantly understates risk for some strategies.(4) If annual expected return exceeds one annual standard deviation (call it 16 times daily standard deviation), and the dollar profit is reasonably large, you can expect rapid deterioration of profit margins. It's too easy to see and imitate strategy.Considering all these factors, I nominate 10 as a reasonable target for Annual profit divided by daily P&L standard deviation. Your results may vary.

Aaron,Thanks for your informative response. Your estimate of:10 x Daily Std. Dev = Approximate Expected Annual P&Lis within the range I had in mind. I was actually thinking that it would be a little lower (around 8)--may be I'm a pessimist? Some traders claim an Annual P/L of 20 times their avg. daily swing. These could be for some trading desks that are exploiting some specific edge, imo. In that case, as you said, these multiples wouldn’t last for long. Or it is also possible that their estimates are just in error…i.e., may be there is a bias to claim, for a given P/L volatility, a higher annual P/L than the actual. I found your analysis of zero-capital investment in S&P 500 since 1925 giving “4 times” factor very interesting. Thanks for that analysis-I didn’t think to look for that. I would think that this estimate also depends on the trading desk’s edge?? That is, for example, the desk might be exploiting some new structure and selling to their clients for a high margin, until it is reverse engineered by the competition. Also, if an options book is structured with long the wings and short the body type of structure and also net long vega—I would imagine any catastrophic event would be positive to the book…i.e., I am wondering whether the way the trading book is structured will also change the factor we are trying to estimate.I am trying to list other variables that would contribute to a high or low number for the multiple. What would they be?So far, between the two of us, the average estimate is 9.-Thanks again.

(2) A zero-capital investment in the S&P500 (buy the index, borrow the money) has returned an average of about 4 daily standard deviations per year since 1925. That does not require any desk expenses. >>Aaron,Would you be so kind to explain 'what is S&P 500 circa 1925'?From 1926 Standard & Poor's Composite has had 90 stocks.It moved from 90 to 500 stocks in 1957.