Lesson Overview

Portfolio Balance & Beta-Weighting

Portfolio balance and beta-weighting are key concepts if you truly want to build an options portfolio that consistently delivers income regardless of the overall market direction. In my opinion, it's the best way to quickly get an idea of how "bullish" or "bearish" in tilt your portfolio is relative to some benchmark index like the SPY or DIA.

Show Video Transcript +

Hey there everyone it's Kirk here again at OptionAlpha.com, and in this video, we're gonna talk about portfolio balance and beta weighting.

Probably one of my most favorite topics to talk about because not a lot of people cover this, and I think it's an insanely important part of your ability to be successful and to focus and streamline your trading is to understand these two concepts.

So, as we've covered previously, it doesn't matter which way you trade the markets with options because you'll get virtually the same probability of success and payout regardless of the direction.

I think probably one or two videos ago here in track two we talked about this and kinda proved this with an example in GDX I believe it was; where it basically showed that if you make a seventy percent chance of success trade in any direction, bullish, bearish, or neutral, you basically have the same win rate and the same payout and risk. So it doesn't matter that you trade the markets.

And now that we've talked about trade size and allocation you that if you keep your positions' sizes small you really can't blow up your account. But this doesn't mean you can be a perma-bull or perma-bear.

What I mean by that is you can't just trade everything bullish, and you can't trade everything bearish. You have to be a little smarter about how you allocate your portfolio. Could you do it and probably make some good money?

Yes, and it would be very, very simple. But we wanna layer on these protection kinda blankets, or filters for our portfolio so that we make sure that we make money regardless of where the market goes.

So the first concept I wanna talk about is portfolio balance. If you have watched any of our videos before, listened to any of our nightly strategy calls, or any videos we've done in the past, you've likely heard me talk about portfolio balance.

And for me, portfolio balance is a key concept because I think it really gets down to the heart of how you can be a non-directional trader and basically make money in any direction the market's going.

It really is good distribution of different underlying securities, option strategies, and multiple contracts to spread risk out. And that's what we're talking about here, spreading risk, not being one hundred percent focused on Apple options, not being one hundred percent focused on Google options, whatever the case is.

But spreading your portfolio across different avenues and areas. So, not only across different securities, so ETFs and stocks, but we're talking about, if possible, things like oil, and gold, and bonds.

Or whatever the case is. Different option strategies, so don't just trade only credit spreads, try to do some iron condors, try to do maybe a calendar or two, try to do some strangles and straddles if you can.

And then multiple contract months meaning try to have a staggering set of contracts, so try to have a bunch of trades for this expiration cycle, and then a handful of trades for the next expiration cycle. Then you can start to build this reoccurring or rolling basis of potential income for yourself with options.

To kind of prove the concept here with you guys tonight, and this is right now at the time we're doing this video, so whatever happens here as far as what we have right here in our portfolio, this is just a good example cuz we can use live, real time stuff.

And this is not paper trading, this is live real money account that we have here, this is my account here at OptionAlpha. And you can see that we have, in our position statement here ...

There's a couple things that we definitely have is obviously we group trades by trade style or option strategy, so put debit spreads, call debit spreads, credit spreads, calendars, butterflies, iron condors, strangles straddles, et cetera.

And you can see we've got a good mix of things. So we've got some iron condors, we've got some strangles and straddles, we've got some just regular naked options, we've got a couple calendars in here, we've got one call debit spread, so we've got a good selection of different strategies.

We've also got a good selection of different ETFs and stocks. So we have the major market indexes which is the Qs, an SPY, but we also have very popular stocks like Apple, and CMG, Qualcomm, we've got some other ETFs in here like XLF and XOP, EWZ, EWW, so we've got a good mix and variety of different stocks and ETFs in here, again just to spread risk out.

It's not like we have all of our trades in Chipotle and all of our trades in Apple. We try to spread it out across the board. And really this is just a basis of understanding that you can go anywhere that you want to as long as you just keep in the back of your mind you don't want to have all of your eggs necessarily in one basket.

So there's no right or wrong way to approach this, there's no perfect formula, there's no perfect scenario, it's not like you can have the perfect setup of ten ETFs and ten stocks, it doesn't work like that. It's just understanding that you should try to get a little bit of diversification in not only strategies that you have, but also in the underlyings that you're trading.

So the other concept that we wanna talk about then, beyond that ... So once we talk about this basic idea of portfolio balance is beta weighting. Now my opinion I think it's the best way to make sure that whatever combination you come up with is net neutral to your benchmark index.

So I'll say it again: It's the best way to make sure that whatever combination of trades you come up with, calendars, credit spreads, iron condors, whatever stocks or ETFs that you trade, that they are net neutral to your benchmark index. Now this is why I say that portfolio balance, as we talked about before,, this is just a good distribution.

Again, there's no perfect formula for that it's just not having all of your eggs in one basket. And it really doesn't even matter what you do as long as you have some distribution. Whether that's different ETFs, different stocks, different strategies, whatever the case is.

Beta weighting kinda brings all of this together and tells you "Okay, based on everything you've picked here's what it would look like if your entire portfolio was basically related to, or relative to some benchmark index that you pick."

Now in my trading, what index that I've picked over the last eight years is SPY. So I always benchmark all of my trades, you'll see these in videos, to SPY. That's the standard [inaudible 00:06:26] ETF benchmark index.

I do that just because that's the major market index. That's the one that everyone follows and I've just followed that before. You can pick SPY, you can pick DIA, the Qs, IWM, pick whatever you wanna pick.

But whatever you pick, stick with that for the rest of your trading career, because you want to get familiar with following one index. So in my case, when I come in every single day, I am most concerned about following SPY. That's the one thing that I'm always looking at.

Yes I know where bonds are, and gold, and I'll check all these things and I'll see what's really moving. But what I'm really concerned about is SPY. Because I know what my portfolio is doing relative to SPY, and where I make money and where I don't relative to SPY. So that's what I'm concerned about.

So here's how we go about looking at beta weighting. So basically beta weighting takes all of these different securities that you have, and all of their relative movements to SPY, and it basically takes your entire basket of apples and oranges and grapes and pears and broccoli, and all these different things that you have.

And it basically converts them all to one symbol. So it says "Okay, if everything you had was basically one big position in some benchmark index, in our case SPY, what would your profit and loss diagram look like?"

Now inside Think or Swim and inside Rose Broker platforms you have the ability to do this. So in our case we go into the analyze tab, we just type in the beta symbol that we wanna look at and that's SPY.

And then down here below we just have to track and say "Okay, we want to look at portfolio beta weighted." Which means we want to take all of the positions that we have, so the position that we have in Apple, the position that we have in CMG, the position that we have in COP, all of these different positions.

We want to make them equal to one big possible position in SPY. And what it basically does is give us this payoff distribution which is this green line here at expiration.

And it basically says "Okay, look: based on everything that you have, if the market SPY lands on any of these price points, or lands in any of these price points, this is what you should make or lose on your overall portfolio."

So again, if SPY is at 190 or 200 or 210 by your expiration date, all the different combinations of trades that you have, whether you're long or short this, you've got credit spreads, or calendars in this, your overall portfolio should either make money or lose money based on these different prices in SPY.

So what's really cool about this is, for example right here at 190: if the market was to land at 190 at expiration; was to trade down to 190 at expiration, and if SPY, again this is all SPY, was to trade at 190 by expiration of this date our portfolio overall would make $2,000 right now as it stands.

And again this gives us a very clear, focused target to look at. Because now I'm not necessarily concerned with losing $100 on CMG, or whatever trade I might lose if the market moves down to that level. Because I'm sure I'll lose on one trade, but if my overall portfolio makes $2,000 I'm okay, I'm still good.

And so this is a concept that most traders don't look at, most traders are too focused on looking at one particular stock or position that they have. And what they fail to realize is that it's not that stock that's necessarily the most important.

And while, yes you should be monitoring each individual position and know what's happening, but what's more important is to understand the combination of stocks that build up your portfolio and how much money you make or lose at different points.

So in our case here you can see this is the zero barrier, this is the point at which we don't make any money. So any time this green line goes below this zero barrier this is when we start losing money based on where the S&P500 is.

But you can see our break even points on the market are between about 180, so just a little bit below 180, and about 211, 210. So if we go to the charts of the S&P500 here, you can see this is where SPY is right now, trading at about 203.12, that's what it closed at the time that we did this video.

So our break even points on our overall portfolio are basically 211 which is here, and 180 which is all the way down here. So here's what this means: as long as the S&P500 trades between this range we make money at expiration on our overall portfolio.

And this is so important because, again it's not just one position or another, it's the overall portfolio we're concerned about. It's making sure that, if the market moves, wherever it moves within this huge range, we don't necessarily care, but we're still gonna make money overall.

And you can't argue with the fact that only options trading gives you a profitable range that freaking wide. There's nothing else in the market that can do that.

You can't trade profitably with this type of window that says basically "Okay market, trade anywhere you want in this entire window. And as long as you land somewhere in here, the combination of stocks that I've built up in my portfolio, or the combination of options trades that I've built up in my portfolio are going to win overall."

So does that mean that, and again just going to draw these lines at 211 and 180, does that mean that if the market were to rally up higher and close at let's say 208, I would lose on XYZ trade, I might lose big on XYZ trade, but I'll still win more on all the other trades that I have.

If the market were to go down to, let's say 190, well in that case I might win on XYZ trade but I might lose on, ABC trade that I have down here. And again, I don't really care because still, overall my portfolio makes money.

And this is a really key concept, in fact it's one of the reasons why I talk about with my pro and elite members portfolio balance so much. Because at this point we don't really care where the market goes.

It can go a little bit higher, it can go lower, it can go dramatically lower. We've got pretty good balance in our portfolio so that we make money regardless of where the market goes.

Now, as we again come back here to this portfolio curve, what's really important to understand here is that, again we should always be working towards being the most neutral we possibly can.

Now in the scenario right now, and again this is live at the time I'm doing this video, this is where the market is trading. Remember, market is trading right now at 203.37 that's that vertical line here on the chart.

And these are all the possible areas that the S&P500 can trade in or SPY can trade in over basically the next month. But the market is trading right here, basically at the star that I'm drawing.

Now when you look at my portfolio curve, which is this green line here, where I make money and where I lose money at expiration and based on that, and where the market is trading right now, my portfolio right now is bearish in tilt.

And I'm going to get into a concept that I'm really passionate about because I think that most people completely miss this opportunity when trading. Basically they're told the complete opposite what they should be doing.

So first you have to understand, my portfolio right now is bearish in tilt. What does that mean? That means that if the market were to move down I actually make the most amount of money.

See, my portfolio curve peaks right here at about 194, 195. That's where I make the most amount of money. So I actually make the most amount of money if the market were to go down to 194, 195.

That means my portfolio is bearish in tilt. That doesn't mean I can't make money right here, I could. And I could still make money if the market goes higher. But I make the most amount of money, based on where the market is right now, and what positions I have on right now, if the market goes lower.

So now the question becomes, or the question you should ask yourself becomes, "What are the new positions I need to add or remove in my portfolio so that I make the most amount of money based on where the market is actually trading right now?"

And this is that concept of being delta neutral, beta neutral in your portfolio. So basically what I want is I really want a portfolio curve that looks like this.

I want a portfolio curve where I make the most amount of money exactly where the market is right now. Now what people fail to do is they fail to do this, which I'm gonna tell you right now.

And they fail to recognize that their portfolio is already tilted bearish, and that what they need to do is actually add more bullish positions to their portfolio. See they do the complete opposite, and I'll show you exactly what people do, cuz you'll hear this all the time.

When the market runs higher like this, they say "Oh, sell, sell sell, sell, sell." Because that's what you want. So you want to add more bearish positions to your portfolio. And that's what people tend to do, whether they're an options trader, whether they're a stock trader.

They see the market running higher, they say "Sell, sell, sell, sell, sell." And yes, the market may move down. But look, your portfolio is already bearish. Remember our portfolio curve here, our beta weighted curve.

We're already bearish, we already will make a ton of money if the market goes lower. Why do we need to add more possible income if the market goes lower? We've already got a big chunk of money over here we can add if the market does head lower.

What we need to do is, we need to respect the fact that the market has made a higher move, and we need to add more bullish positions to our portfolio. So that what we do, is we basically start to shift and tilt this payoff curve like this.

Basically we shift out the right side and we pull back in the left side, so that we have a payoff curve that looks more like this over time. We start adding more bullish positions that make money as the market goes higher.

Not removing necessarily any of our bearish positions right now, those are still good. But we just need to transfer that risk from one side of the portfolio, to another. And what I usually say when we talk about doing this is basically trading the direction of the market.

So we're basically trading what the market gives us. So if the market continues to move higher, then guess what we're gonna do? We're gonna continue to add positions that profit if the market moves higher, therefor reducing risk.

Because what a lot of people end up doing is they say "Okay well we need to add more bearish positions." Well what if the market goes higher?

You just added even more bearish positions when you already had a bunch of bearish positions on. What you should've done is you should've added more bullish positions that would make money if the market goes higher.

You'll see this in the reverse as well and this is, again I'm so passionate about this concept because I think people get it wrong all the time. You'll see the market make a huge downward move like this, like it did back in early 2015.

Huge downward move like this. And what you'll hear people say is "Oh you have to load up. You've got to get even more bullish. You've gotta average in. You've gotta double up." Whatever the case is.

Well who's to say that the market couldn't have just continued to move lower and now you've doubled up on your position? If you had a neutral portfolio, meaning that you were trading in this time period, and you could make money around, say the 206, 205 level, If the market moved lower, your portfolio is naturally bullish.

Let's take an example here, with SPY. So let's move this out for a second. Instead of the market being here at 203, let's say tomorrow the market opens up and is down at 185. So again, same positions that we have, same trades we didn't do anything else, but now the market opens up lower to 185.

Now our portfolio is bullish in tilt, meaning that we make the most money if the market comes back higher to 195, still the same target level, but now our portfolio is naturally gonna be more bullish.

We didn't do anything, it's just how the portfolio then shifted with the market. What we need to do, if the market were to open up at 185 tomorrow, is we need to add more bearish positions, so that we can transfer risk and hopefully protect ourselves in case the market moves down.

And that's the whole concept of what we're trying to do here with this portfolio balance and beta weighting, is just give ourselves a target, which again in my case I always use SPY.

That way I know exactly where everything is in my portfolio relative to SPY. So that I can use one target as the means for adjusting and looking at all the trades that I'm doing.

And again, this is a great concept to master and understand, get in here every single day and kinda look at your portfolio. In fact, look at your portfolio right now. Add a comment in the comment box right below this video, let me know what you've learned already on this video about where your portfolio is and how balanced your portfolio is or not.

So insanely important to your understanding of how to be successful. Now in my opinion,, I think what it comes down to is basically the fact that we should always be working towards neutral.

That if the market were to move higher, then we have to move the center of our portfolio which is currently at say 196, 195 or so. We have to move the center of our portfolio higher by adding more bullish trades, so that we make money if the market stays here.

And that's always what you want to try to be doing. You want to try to mirror and follow the market so that you are overall non directional. You can see right now we're pretty non directional.

We're a little bit bearish, we'd love to see the market move down, but even if the market moved up to 211 after the huge run it's had, we'd still make some money at expiration with all the positions that we have on. And that's what's really important about this concept.

So again, balance and neutrality is always the goal, and a constant moving target. But if you focus your attention on protecting the overall portfolio versus any single position, not that you should ignore single positions so don't get me wrong here, but if you really focus on the overall portfolio, and the profitability of your overall portfolio relative to a benchmark, it really guides you on future trades that you need to look for.

If you come in to a situation where you are super bearish, where you make the most amount of money if the market goes down, then that should naturally tell you that you probably need a couple more bullish positions in your portfolio.

Now you know what to look for. Now you know you can go out and start searching, scanning, deliberately for trades that might be bullish in nature because you need more bullish trades on your portfolio.

Two I think you should ask yourself all the time, At least every week, if not every day if you're a little bit more active in your trading. Number one is "Is my overall portfolio neutral to the SBY?"

Or replace SBY with whatever benchmark index you're gonna use. But again that question then guides you as to how you're going to structure the trades you're looking for.

And it basically gets you out of the mentality of running around like a chicken with your head cut off, basically looking for anything that you can find, and it pinpoints your focus into the exact types of trades that you need to be more balanced and more neutral.

In my case right now, like I said just to use this as a great example, my portfolio, based on where the S&P is right now, is naturally a little bearish. So I can naturally go out and say "Look, I don't need any more bearish trades, What I actually need more bullish trades."

So I'm gonna look for possible candidates that might fit my bullish kind of criteria to make a bullish trade, or to make a directionally bullish trade. I can still sell options, and do it bullish. So it's not that I have to buy long options, long calls.

I can still sell options, and do it in a bullish manner. But now I know exactly what I'm looking for. Number two is "What trades do I need to add or remove?" So this kind of piggy backs on number one, but it's really a good question.

It's "What trades do I need to add or remove?" And it helps you define where you are net neutrality with your portfolio. Are you bullish or bearish already? And if so, does that mean you can add or remove some positions?

So look at your portfolio and say "What happens if I add this position that was really profitable and that's already made some money? Or remove this position that was already profitable and made some money? How does that effect my overall portfolio? Does that make me more bearish or more bullish?"

And so I think answering these two questions, and at least asking yourself these two questions, every single week, or every single day if you're more active as a trader, is gonna help you become a very successful options trader in the future.

Because now you're not gonna be whimsically moving with the market. You're gonna have a huge profitability range with regard to wherever the market moves. And you're gonna maintain that throughout.

So, as always, hope you guys enjoyed this video. Thank you so much. I would love to hear your comments and feedback on this concept. I don't think that enough people talk about it.

Hopefully we covered it good here in this video tutorial in track 2. If you love this video, please share it online, help spread the word about what we're trying to do here, at OptionAlpha. And until next time, happy trading.

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