2. Portfolio Management Concepts

3. Why Portfolio Management
Designing a Balanced Portfolio has Huge benefits
More Consistent Profits Each Month
Lower Overall Risk
Dramatically Reduced Risk of Losing Everything

4. A Few Things to Think About
Before we get into Portfolio Management and complex Risk ideas lets go over some very basic rules about trading and risk.
* I considered calling this the depressing reality section 

5. Our Job is to Take Risks
Nothing is guaranteed and if it were there would be no profit in it
Higher potential profits are almost always coupled with higher potential losses
A good trader looks for opportunities where the profits are disproportionate to the risks - We call this the Edge

6. Markets Don’t Give Money Away
To gain an advantage or get an Edge in a trade you need to earn it.
Getting an Edge in a trade means you…
Understand the Opportunity Better
Understand the Risks Better
Execute the Trades Better

7. Too Good to be True??
Look out for trades that look like they are giving you very high profits for little risk
The poker adage applies – If you sit down at a poker table and can’t spot the sucker, it’s you.

8. Remember Rule #1 ALWAYS make sure you will be able to trade tomorrow
Never take a trade that could wipe you out completely, even if that possibility is VERY remote
Never put all your money on one bet, no matter how confident you are

9. Even the Best Traders Lose
Every Trader – Good, Great or Horrible will have losing Trades
Not letting losses ruin you separates the long term winners from the losers

10. Down is Faster than Up
Losing money happens faster than earning it back.
If you lose 20% of your portfolio it takes a gain of 25% to get back up to break even
Minimizing the downside can have a very positive effect on your portfolio.

11. On the other hand…
Trading gives you complete control over your own destiny
You succeed or fail based on your own choices
The level of success you can achieve is nearly unlimited
You can do it from anywhere
You can do it at almost any time
You can take vacations whenever you want
Trading is all up to you and that can feel very good (and sometime bad)

12. Basic Risk Management
Decide on how much of your trading account you will use
I normally have roughly 30% cash in my account
This lowers my overall returns but increases my flexibility
More cash if trading is challenging or uncertain

13. Underlying Diversification
Trade on a wide variety of underlying symbols
Don’t concentrate all your risk is one symbol
Limit the amount of risk per symbol to a percentage of your portfolio (1% to 2.5% is a common range)
Greater diversification is better – lots of small trades
At least 20 different trades(different symbols) is a good start
More diversification is better, but the incremental advantage of diversification goes down as you add more and more trades

14. It is a time tested idea
Diversification is mentioned in the Bible, in the book of Ecclesiastes which was written in approximately 935 B.C.:
“But divide your investments among many places, for you do not know what risks might lie ahead.”
Diversification is also mentioned in the Talmud. The formula given there is to split one's assets into thirds: one third in business (buying and selling things), one third kept liquid (e.g. gold coins), and one third in land (real estate).
Diversification is mentioned in Shakespeare (Merchant of Venice):
“My ventures are not in one bottom trusted, Nor to one place; nor is my whole estate Upon the fortune of this present year: Therefore, my merchandise makes me not sad”

15. Why Diversification Works
If you have a 1 in 10 chance of losing $10,000 in one trade the weighted risk of the situation is $1000
10% Chance * $10,000 = $1000
If you have 2 trades each with a 1 in 10 chance of losing $5000 the weighted risk of the situation is $600
10% Chance * $ % Chance of losing $10000

16. Advantage of Diversification

17. Symbol Diversification Can Fail
The advantages of symbol diversification rely on all the trades being independent
Systemic Risk and Market Correlation
Sometimes the whole market moves together
A large number of trades fail at ones

18. Long Short Portfolio Concept
A portfolio is created consisting of ½ Long Trades and ½ Short Trades
Each trade MUST have a good probability of success on its own
Market goes down the short trades win and long trades lose(but less)
Market goes up the long trades win and short trades lose(but less)
In flat markets both sides typically win
Very common hedge fund strategy
Lower overall returns, but significantly lower risk
Neutralizes the effects (good or bad) of the overall market
The goal is a portfolio that returns 80% of the typical market returns, but has ½ the risk

19. Market Neutral Options Portfolio
2 basic types of systemic risk in options
Delta Risk
stock moves opposite the trade direction
Vega Risk
Implied Volatility Rises or Falls adversely affecting the position

20. Delta and Vega Explosions
The market can suddenly move either up or down
IV can very quickly increase across the whole market
IV can also settle down further than expected
All of these effects have the potential to cause losses in a large portion of your portfolio

21. Minimize Systemic Risk Exposure
Each option you trade adds or subtracts Vega and Delta exposure to your portfolio
Long Calls are Positive Delta and Vega
Short Calls are Negative Delta and Vega
Long Puts are Negative Delta but Positive Vega
Short Puts are Positive Delta but Negative Vega

22. Delta Neutral Trades Delta Neutral trades can be Long or Short Vega
Iron Condors are Short Vega – sensitive to IV increases
Straddles & Strangles are Long Vega – Sensitive to IV crashes

23. Basic Approach - Delta Sum up your Deltas across all of your contracts
Get a sense if you are excessively Long Delta or Short Delta
Attempt to choose trades that Reduce your exposure to Delta
The goal is as close to 0 as possible

24. Basic Approach - Vega Sum up your Vegas across all of your contracts
Get a sense if you are excessively Long Vega or Short Vega
Attempt to choose trades that Reduce your exposure to Vega
The goal is as close to 0 as possible

25. Choose Good Trades
Each trade you add to the portfolio needs to make sense on its own
The choice to increase or decrease your Delta or Vega exposure should come after you have found good trades

26. Diversified Neutral Portfolio
Limited exposure to major changes in the markets
A few bad trades will not be devastating
More consistent returns
Reduces average overall profit a little
Reduces portfolio risk a lot

27. What about Indexes
Can I use a Synthetic VIX or VXX contract to offset my Vega exposure?
Yes, this is both good and bad
It is very effective at offsetting Vega exposure
It uses lots of margin without getting you any specific edge in the market – dilutes returns further
Stock Indexes can be used the same way to offset Delta exposure
This has the same issues as above

28. How to Use
Start simple
Periodically evaluate your portfolio for Delta and Vega exposure
Just add up the current values from all your trades
Set goals to reduce your exposure
If Delta or Vega is high attempt to take more Short Delta or Short Vega positions

29. Keep the Goal in Sight Watch your Exposure to Delta and Vega
Widen the style of trades you take to give you more tools to adjust your exposure
Eventually you will get in the habit of maintaining a relatively neutral portfolio

30. Keep Your Focus
The value of portfolio management may not seem obvious every day when you are trading
It is easy to slack off and just focus on the trades you are excited about
The real value of this approach becomes apparent when the market suddenly changes
Other traders will be losing money badly and your portfolio will be strong

31. Exits and Adjustments

32. Top Level Idea
The overriding goal of trading is to use money to make money as efficiently as possible. When choosing Exits and Adjustments this should be kept in mind.

33. Exits
Every Trade has a an Exit, but the time and effort we put into the Entry often Dwarfs the effort put into the Exits. Trade Exits are often an Afterthought.

34. Why? Maybe closing a trade just isn’t as fun
When things are going bad exit decisions are stressful
You already made your choices in the beginning of the trade
Stop Losses
Take Profit Points
Timed Exits

35. Things to Think About Focus on maximizing your use of money
Exits are a large part of that
Every moment you have money locked up in a trade it costs you
Opportunity costs – is there a better trade for you to be in
Exposure to Risk – Open positions have risk
What is the remaining value in the trade?
Is it worth the time and risk to get it?

36. Normal Reasons to Exit Hit a Profit Target Hit a Stop Loss
Options are expiring
Time limit on trade
Get out before an Event

37. Other Reasons to Exit 1 Rapidly made a profit Be happy!!!!
You just made a quick profit, lock it in
Take your Money and use it in a new Trade

38. Other Reasons to Exit 2 The Reason for the Trade has Gone Away
Trading should be deliberate and done for a reason
If the reason for a trade changes you should exit the trade
This is important and often ignored

39. Reevaluate your Trades
Have a schedule for reevaluating your trades
These are your trade way points
Would you place that trade right now?
Is the Risk/Reward going forward good?
If the answer is no you should consider closing the trade

40. Always Have Alternatives
People are unsure what they will use the margin for. Keep a list of solid trades available. This makes it easy to know where you can use the margin you are getting back from closing a trade.

41. Adjustments Rule 1 – Stop Using the Terms Adjustments or Repair 
Sorry, a bit of a pet peeve
In Reality you are closing one Trade (good or bad) and Opening a new Trade
The rules you would normally apply to Entering and Exiting Trades should apply

42. Example – Iron Condor Two Separate Decisions Bad Call Side
Good Put Side

43. Example – Bear Call Spread
Quick Profit
Close the Trade and Take the Money
Can we do it again?
Is the new trade a good idea on its own?
Yes – Create a New Bear Call Spread (More Money)

44. Example – Bull Put Spread
Stock is Going Down

45. Walking In Iron Condors
Walking it in
As time passes the Deltas of your Short Strikes go down
Price movement can affect this on different sides
Close the profitable Bear Call or Bull Put and re-place it at close to the original delta
Capture Profit and set up for more Profit
This can increase your profit potential with Iron Condors while not actually increasing the risk of your trade past the initial risk
Downside – you are giving up the benefit of the risk decreasing with time