Options portfolios……

A portfolio made up of options is completely different from a stock-only portfolio.  The options industry grew out of a risk-management product. If you are an options trader, you are a risk manager who is running a small insurance company. You get paid to accept a defined amount of risk for a defined time period.

Options traders have tools to easily analyze risk in many different ways. My favorite tool is Delta that is Beta Weighted to the DIA. This is the SPDR Dow Jones Industrial Ave ETF Trust. With the DIA, you can buy and sell the Dow Jones average as if it was a stock. The DIA owns all of the Dow 30 stocks and the idea is that DIA mirrors the movement of the Dow Jones Industrial Average so that you can easily trade it, if that is your desire. It works well, and is very heavily traded. My portfolio contains a lot of DOW stocks, so I need a good way to measure the risk of my portfolio. By weighting it to the DIA, I get a good idea of my market risk for the entire portfolio, and I can also see the same Delta (risk) for each position.

Let’s work at understanding just how this works. I will invest $10,000 and split it up among 3 different Dow stocks, $3333 in each. I want to know, as the market moves around, what is my risk? If I use the software to Beta Weight my 3 stocks to DIA, it may say my total Delta is 100. This tells me that, if the DIA goes up by $1, I should see my portfolio increase by $100. If the DIA goes down by $1, I should see $100 in portfolio go away. There numbers are purely theoretical, but  in the real world, your Delta number will correctly define your risk.

My portfolio Delta is 100 – I make or lose $100 for each $1 of movement in the DIA. I can change that Delta number by purchasing or selling options. That’s a long discussion and one that we will get into over time. Today I want to explain how an Options portfolio makes money.

I know how much my 3-stock portfolio will make or lose as the DIA moves around, so I am now prepared to see that without emotion. Price movement is expected, and predicted in a way that I understand. I have started with a $10,000 portfolio and over the next week I sell calls against the 3 stocks I own. I create daily time decay of $5 and I see that as my Theta number in the analysis tools. I know I am being paid $5 a day for the risk I have accepted by selling the options. On a day when the DIA moves down $1 (the DJIA loses 100 points) I expect to see my account lose $100. But I know that the daily time decay is $5, so I might think about the fact that I just lost 20 days worth of time decay, OR I might think about it a little differently and realize that I will be back to even in 20 days if nothing else changes.

The stock portion of your portfolio will go up and down, your account value will go up and down, but all the time it is collecting $5 a day. Over a month, you will have made $150 whether or not your stocks are up or down. Doesn’t matter – you still collect the time decay on your inventory. Over the course of a year, the DIA moves around and some months you are up, some months you are down, and it finishes the year exactly at the same number where it began. If you own stocks and nothing else, you collected some dividends and that’s your entire gain for the year – maybe 2 or 3%. If you kept your Theta at $5 a day for the entire year (365 x $5) = $1825 for an 18% gain. You still got the dividends, too for an additional 2 or 3%. This is what we do at DeepPocketOtions.

Stay Optioned, My Friend!


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