Single Positions vs. Overall Portfolio Management – Which Is More Important?

You're in a trade that's going bad and are thinking about adjusting your position. But before you do, how would that adjustment impact your overall portfolio management? Would it make your portfolio more bearish, more bullish, or have little effect at all?

Asking yourself this question above before adding or adjusting your positions gets to the heart of today's podcast episode. Too often I find that options traders who spend the bulk of their time concentrating on single trades that go bad, without any regard for the overall portfolio impact, actually cause more harm than is intended. They become so narrowly focused on making sure "this trade" doesn't lose money that they completely forget about the rest of the portfolio that is profitable.

Maybe they have a bearish trade that's going against them as the stock market rallies. And the first natural thought is to adjust this trade and protect them from the impact of the market rallying. But, if this is your only bearish trade in a portfolio full over five other bullish trades, why bother? Sure, adjusting this trade would help reduce risk in the single position, but the overall portfolio is already super-bullish that you'd just be putting yourself in an even bigger pickle should the rally halt and reverse course.

Today's episode challenges the popular saying, "What's good for the goose is good for the gander" because, in our opinion, the health of the overall portfolio is more important than any one, single option trade. Sorry little goose, we love you, but I'm okay sacrificing a couple of geese for the welfare of the flock.

Key Points from Today's Show:

One should always be managing both single positions and overall portfolio, independently first. You have to look at the individual position and the impact that they have on the overall portfolio — the sum of all the parts is more important than the individual pieces.

If you make a bullish trade in FXY, FXY actually has negative beta, meaning that as FXY goes up, it is like having a negative position on the S&P 500. Therefore it does not necessarily correlate 1:1.

ETF’s work similarly — when trading TBT, an inverse bond ETF (bonds work inverse of the market), it creates a double inverse factor in the portfolio making it harder to evaluate overall portfolio performance.

The way to simplify everything is to beta weight your entire portfolio to one index, and always follow that index - always use the same benchmark and same target for your overall portfolio.

Portfolio beta weighting to one index takes everything and makes it an apples to apples comparison, so you can see the overall effect on your portfolio.

When making adjustments, again you have to think about the impact on the individual trade and the overall portfolio. The best adjustments you can make to have a great impact on the individual trade and the adjustment also works well for the overall portfolio.

EXAMPLE 1:

You have one bullish trade and five bearish trades in your portfolio. If that one bullish trade is going bad, meaning the market's going against you, but all five of your bearish trades are going well, do you really need to do anything to that bullish trade?

Looking at the individual position of the bullish trade, you might be tempted to adjust it. But say you are losing $100 dollars on that bullish trade, and you are making $100 for each of your bearish trades. Then overall you are positive $400 in your account because most of your portfolio is bearish, and that's the overall direction of the market/sector that you are trading. So, therefore, in the context of the overall portfolio, there is no need to adjust the one bullish trade because you are still positive $400 in your account thanks to the five bearish trades.

EXAMPLE 2:

We have a bearish position in Solar City that's completely bad. We thought it was going to go down, but it when much higher than we thought. We took a debit spread position and thought Solar City would move lower. This position will end up probably losing about $330. However, every day that Solar City loses say $20, then the overall portfolio will make back say $50. So in context of the overall portfolio, the other bullish positions made up for Solar City loss, and then some.

EXAMPLE 3:

Assume that your portfolio is already very bullish, that when you beta weight it to SPY it gives your portfolio curve with a bullish tilt. Meaning, if the market generally moves higher it will be really good for the overall portfolio. Now say you had a single bearish position that was losing money and the market was moving higher — you sold a credit call spread on Facebook and thought it would go lower but it ended up going higher with the rest of the market. You are losing money on Facebook, but your overall portfolio is still making money because the market is going higher and that's where your portfolio is beta weighted to.

So you could potentially adjust Facebook by selling a credit put spread on the other side of Facebook, below Facebook's price, and turn it into an iron condor making that position more neutral. However, you probably do not want to do that because if you adjust Facebook, then you are just going to make your portfolio even more bullish than it already is. Therefore, leave the Facebook position as is and keep some of that bearish exposure in your portfolio. Can even start to remove some of your bullish exposure, or find trades that are bearish in tilt, in order to move back to neutral.

EXAMPLE 4:

Assume your new portfolio has a bearish tilt. So then when you beta weight the portfolio, you generally want the market to go down, which will help your overall portfolio. Say you still have that credit call spread in Facebook. So you are bearish on Facebook, and the market continues to go higher. Now, in this case, it makes sense to adjust Facebook by selling a credit put spread and turning it into an iron condor. This adds a bullish trade to your portfolio, which works well on the individual basis and helps you become more beta neutral to the market by giving you bullish exposure when your overall portfolio has a bearish tilt. Therefore an adjustment, or managing this position, works well for both the individual trade and overall portfolio.