Sharpe Ratio
How much profit per unit of risk you're actually taking
Definition
The Sharpe Ratio measures the risk-adjusted return of an investment, developed by Nobel laureate William Sharpe. It calculates how much excess return you receive for the extra volatility of holding a risky asset compared to a risk-free asset (typically U.S. Treasury bills). A Sharpe Ratio above 1.0 is considered good; above 2.0 is excellent; above 3.0 is exceptional. A negative Sharpe Ratio means the investment underperforms risk-free assets.
Formula / Rules
Sharpe Ratio = (Return − Risk-Free Rate) ÷ Standard Deviation of Returns
Example
An options strategy returns 18% annually with a standard deviation of 12%. The risk-free rate is 5%. Sharpe Ratio = (18% − 5%) ÷ 12% = 1.08. This is a good risk-adjusted return — you earn 1.08 units of return per unit of risk. If the strategy returned 18% but with 20% volatility, the Sharpe would drop to 0.65 — worse risk-adjusted performance.
Related Terms
Frequently Asked Question
What is the Sharpe Ratio?
The Sharpe Ratio measures return relative to risk — excess return divided by standard deviation. Above 1.0 is good, above 2.0 is excellent. It lets you compare strategies that have different risk levels.
APA Citation
Last updated:
· Source: VixShield Trading Glossary — From SPX Mastery by Russell Clark
⚠️ Not financial advice. This definition is educational content from the SPX Mastery book series by Russell Clark (VixShield). Past performance is not indicative of future results. Trading options involves substantial risk of loss and is not appropriate for all investors. Always paper trade before risking real capital.