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How to create a portfolio of options

How to Create base Portfolio for Options Trading,

While a volatility approach is far from traditional, some aspects of "diversification" are still applicable to options trading. Concentrated exposure in the volatility realm is a potential pitfall, and must be actively risk-managed.

Traders seeking to learn more about diversifying an options portfolio will find a recent episode of Options Jive extremely interesting.

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On the show, the hosts discuss in detail four diversification categories traders can keep in mind when filtering for opportunities. How to create a portfolio of options four categories of diversification outlined on the show include: underlying strategy expiration As a reminder, concentrated risk in a traditional long-short portfolio basically indicates that exposure to unsystematic risk is high.

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For example, an investor that chooses to go long bonds only in one specific country or region i. A volatility portfolio can also be exposed signals application for binary options unsystematic risk.

Even better — it can be a big key to more income in retirement, which is exactly when you need it the most. Of course you would! That is why we believe the 1 Job of your portfolio is to produce a paycheck. Income replacement is the goal of retirement planning.

While the approach may fit the trader's chosen strategy, the net result of the positions is concentrated exposure to price volatility in crude oil. If volatility increases i.

In competitive markets, though, no one expects to formulate a detailed long-term plan and follow it mindlessly.

By deploying three extremely similar positions, the trader has effectively doubled and then tripled down on the original bet. On Options Jive, the hosts discuss how the four high-level categories listed in the bullet points above can help traders build a more diversified portfolio.

It's a contract that gives its buyer the choice of executing or not executing the deal. The seller, also called the underwriter, has the corresponding obligation. The buyer of options pays a fee to get the privilege of deciding on implementing the contract. Here's how it works. Suppose you strike a deal to buy a house for Rs 50 lakh, but need six months to raise the money.

As we know, stocks in the oil sector are highly correlated to each other and to the price of crude. By adding more underlying symbols from the same sector to our portfolio, we are increasing our exposure to concentrated risk - especially if the position i.

The chart below shows how traders can measure the correlations between underlying symbols to ensure they are building diversified options portfolios: When underlying symbols possess low positive correlation, no correlation, or inverse correlation, the unsystematic risk within a volatility portfolio is reduced.

Along those lines, the second area of diversification that traders can consider is implied volatility.

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Much like correlation between underlying symbols, the correlation of implied volatility can also be monitored. A chart is presented on Options Jive that presents data related to the correlation of implied volatility across the financial landscape - commodities, how to create a portfolio of options, and foreign exchange - which we think will be useful to traders in further analyzing potential trading opportunities and overall portfolio exposure.

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The third diversification category discussed on Options Jive relates to strategy, or position structure. The hosts highlight how traders can deploy a variety of position types to build a diversified portfolio. For example, consider Portfolio A which is comprised only of short put sales versus Portfolio B which includes a wide variety of option positions strangles, straddles, short puts, covered calls.

The net exposure of Portfolio A and Portfolio B are extremely different.

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A helpful chart is included on the episode which traders can use to better understand the correlation between different option position structures. The show concludes with a discussion around how traders can diversify by maturity expiration month.

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For example, if a trader has deployed a handful of short straddles in only one expiration month, the net exposure of that portfolio is once again much different than a trader who has deployed a variety of position structures across the timeline of maturities one week, two weeks, one month, etc Disciplined portfolio management is a key aspect to trading options, just as it is when trading a more traditional long-short approach.

We look forward to hearing from you!

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Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe. Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

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