Diversification for small portfolios


When we talk about selling options in the form of strategies like the short Strangle, we often start with the profitability of the trade. When was it particularly profitable? When should we maybe reduce trade size? How does buying protection affect that profitability? And while these questions are all important, they are nothing without an underlying diversification in a portfolio of short options.

Diversification is the product of using similar strategies on various markets that have weak correlations to each other; that is, markets that do not move up and down with one another. By adding this diversification to our portfolio, we reduce the tendency of our profits and losses being tied to a single market, usually the broad equity market.

Tom and Tony set out to put historical numbers around a diversified portfolio of short Strangles and one with the same amount of capital allocated, but with only one market in mind. What does this diversification actually get you in the profit/loss column?

The Study

We sell stangles to collect option premium


Diversification small portfolios

The Results

Firstly, we found that each Strangle was profitable individually, but that wasn’t much of a surprise. The guys go on to compare the statistics of the two portfolios while injecting their own personal biases as well. The key result found here was that the diversified Strangle portfolio witnessed half the fluctuations in returns that the alternative did.

We use correlation to gauge relationships between markets, and we build our portfilio with markets that do not move together to add diversificatin.

When we have spread our short premium trades out over uncorreltated markets, we have seen sililair profit with much less variance from trade to trade.


Tradestudy from TastyTrade.com

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