4 Ways To Fix Unbalanced Investment Portfolio

I know one of the key elements to successful options trading long-term is maintaining an investment portfolio that is consistently balanced. And when I talk about balance, I'm not talking about 80% stocks and 20% bonds - that's portfolio diversification. Unlike traditional investment strategies that favor 99% of the portfolio invested in long equities and bonds with minimal short exposure, what I'm specifically referring to here is the concept of trading a mix of bullish, bearish and neutral positions all the time which gives us a much smoother and solid equity curve.

One of the best ways to measure overall portfolio balance is to beta-weight the portfolio to a benchmark index like the S&P 500 (SPX or SPY). This metric gives us an apples to apples look at how the portfolio as a whole would perform when the market moves higher or lower. And once you start monitoring the beta-weighted portfolio you'll notice that sometimes your positions can become unbalanced and lopsided.

Key Points from Today's Show:

One of the keys to being successful in trading is having a balanced portfolio and making sure that you positions are neutral around the market.
When you have balance and neutrality around the market, creating a much smoother equity curve.
However, as long as you are trading with 70% chance of success, you should hit 70% or more over time, regardless of where your portfolio is set up.

Example:

You could make all of your trades directionally bullish, and as long as you are trading with 70% chance of success, you should hit 70% wins over time. This applies when making all your trades directionally bearish as well. However, your equity curve will not be as smooth as if you were to trade both sides of the market.

Why Have A Balanced Portfolio

Trading both sides of the market helps give your portfolio a smoother equity curve.
If you only trade one side of the market, it will create big swings in your account.
Avoiding these big ups and downs with a balance gives you greater confidence in your portfolio.

What Does Perfect Balance Look Like?

There is no such thing as a perfectly balanced portfolio.
The goal is to aim for a Delta neutral portfolio but never actually achieve it.
When you have a Delta neutral portfolio and it is exactly balanced to the market.
This causes your positions to move every time the market moves.

What is Considered Unbalanced?

The easiest way to check for unbalance is to use beta weighting, creating an equity beta-weighted portfolio curve in your broker platform.
An unbalanced portfolio occurs when the market is trading very close to one of your break-even extremes.
At that point, you have to make adjustments to get it back to neutral.

Four Ways To Fix An Unbalanced Portfolio:

1. Add More Neutral Positions

Adding more neutral positions — iron condors, iron butterflies, straddles, strangles — raises the whole portfolio vertically.
This pushes your equity curve higher, and as the market moves your portfolio moves and becomes more neutral around the market.
This is a longer-term strategy and requires you add many new positions to rebalance your portfolio.

2. Add Directional Credit Spreads

In the case of being too bearish, add put credit spreads to start making money if the market goes higher.
This starts to shift the risk away from bearish trades and more towards bullish trades.
Likewise, if your portfolio is too bullish, add call credit spreads to even out your distribution curve.

3. Add Directional Debit Spreads

This adds a much more rapid inject of transfer of risk in your portfolio, rebalancing your portfolio much quicker.
Directional debit spreads are the quickest way to facilitate the adjustment to your portfolio.
The directional debit spread is generally added at the "at the money strikes".

Example:

If the stock is trading at $100, you are adding the $99/$101 call debit spread. You are buying the $99's and selling the $101's, and if the market starts moving higher you immediately start making money.

4. Use Skewed Calendars and Diagonal Spreads

This can be done during low implied volatility, which is generally when these work better.
Trade these skewed calendars and diagonal spreads in the direction of where you want to make money if the market moves.
Calendar and diagonal spreads make money at a slower pace, and slower to react to market movements.

Example:

If your portfolio is too bearish and you will already make money if the market moves lower, you need to add positions that give you an opportunity to make money if the market moves higher. Call calendar spreads will be added and placed in the direction of where the market might move higher — above the market or above some ETFs in case they rally higher.

*Do not need to do as many debit spreads or calendar and diagonal spreads because just the fact of staying active and adding positions every week will naturally adjust as the market moves up or down.