Do You Recognize These 4 Early Warning Signs of a Non-Diversified Options Portfolio?

Here is a look at four situations you need to be aware of when building out your portfolio. These early warning signals of a non-diversified options portfolio can help you adapt more quickly to an ever-changing market by making smarter trades and adjustments.
Do You Recognize These 4 Early Warning Signs of a Non-Diversified Options Portfolio?
Kirk Du Plessis
May 7, 2018

As options traders focused on income generation, it's important that we consistently maintain a diversified options portfolio. Are there any "early warning signs" that we are starting to lose our grip on balance? In today's podcast, I've put together four things to monitor so you don't wake up tomorrow and realize you've got a non-diversified portfolio that needs major repairs.

1. Large Swings in P&L

  • If you have large swings in your P&L daily, this is probably a sign that you are not diversified or neutral enough in your positions.
  • Generally, you want to see a slow and steady rise in your P&L every single day. 
  • You want to minimize the volatility in your account as much as possible when you see this first early warning sign. 

2. Non-Normal Beta Portfolio Curve

  • When you start beta-weighting your portfolio, an early warning sign is a curve that does not look like a normal bell-standard curve.
  • A rigid, abnormal curve will indicate that you do not have enough positions that are complementary to each other.
  • To adjust, you would need to start doing some digging into what positions are creating the unbalance or begin adding new positions to re-shape the beta-weighting curve.

3. Too Much Industry or Sector Consolidation

  • When looking at your ticker symbols, if you have too much industry or sector consolidation, this will indicate a non-diversified portfolio. 
  • Make sure to diversify your trades in different sectors and industries to avoid this type of consolidation. 
  • Try to spread out your trades over different industries and sectors as much as possible to avoid having all your eggs in one basket. For example, a major index, bond exposure, precious metal, currency exposure, commodities, emerging markets, and then a few sector ETFs. 

4. Distribution Between Front and Back Month Trades

  • Often, traders get too focused on the current month of trading and forget to start building out trades in the next month.
  • When an unexpected, large market shift happens, the front-month portfolio becomes more dramatically impacted than the back-month portfolio.
  • If you haven't started building out trades in different expiration periods, then it leaves you open and vulnerable to having to adjust quickly or force trades simply to get back to neutral. 
  • To prevent this, start building out your portfolios ahead of time — at least two to three months.
  • You want to have a good distribution of trades across different months to always have a constant, steady stream of trades coming in.
  • This will keep your portfolio balanced and neutral. 
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