Managing Portfolio Theta
Nov 21, 2016
By: Sage Anderson
Being a successful trader can often hinge on an ability to adjust.
This could be as simple as reading a news alert and quickly re-structuring a position to take advantage of a new opportunity. Or, it could be the ability to think around corners when surprising developments occur that affect the bigger picture (i.e. the recent Presidential election in the United States).
The tastytrade financial network does its utmost to not only discuss and analyze current affairs, but also present a variety of options (pun intended) for expressing one's view in the marketplace.
One key that can be used for unlocking your innate ability to adjust is to embrace an attitude of continuous learning. If you are open to improvement, you can equip yourself with an increasing ability to take advantage of a greater spectrum of opportunities.
In a recent edition of From Theory to Practice the host (Dr. Jim Schultz) introduces another way of thinking about theta - specifically as it relates to overall portfolio management. A comprehensive understanding of the information presented on this edition of From Theory to Practice may be one such opportunity to build up your arsenal of trading knowledge.
Theta of course is one of “the greeks,” and more specifically the one that measures the rate of change in an options price relative to time (a.k.a decay). Options have specific expiration dates, so as time progresses (all else being equal), the value of an option goes down.
Looking under a microscope at a single option trade, this means that when you sell an option you can expect to theoretically collect a small portion of its value on a daily basis. Your position benefits when the underlying sits still.
On the other hand, purchasing an option means that you'll theoretically lose your theta on a daily basis, and that you are hoping for a move in the underlying stock that increases the value of your option (or increases the value of a hedge associated with the option).
On the episode referenced above, Dr. Schultz walks viewers through his perspective on theta at the portfolio level. Portfolio theta is the net value of your various positional theta. For example, if you are collecting $100/day of theta in XYZ and paying $100/day of theta in ABC, then your net portfolio theta is zero.
The point Dr. Schultz is trying to drive home is that while the deployment and management of individual positions is very important, strategic control of theta at the portfolio level can be equally critical.
One of the key elements that Dr. Schultz uses to illustrate portfolio theta is the "1/10th of 1%" concept he has discussed in the past. 1/10th of 1% (or .001) is a guideline that can be used to help approximate your net portfolio theta. In the example used on the show, an account with a value of $100,000 would result in a net portfolio theta of $100 ($100,000 x 0.001 = $100).
A portfolio theta of $100 would mean that a trader theoretically collects $100/day in decay. Taking that number and multiplying it by 360 days in a year would therefore result in portfolio of this size theoretically collecting $36,000 per year (360 days x $100/day = $36,000).
Dr. Schultz then goes one step further and applies this theoretical return to an episode from another series on the tastytrade network. On Market Measures earlier this year, hosts Tom Sosnoff and Tony Battista present a study of historical S&P data that suggests a portfolio may capture approximately 25% of the total theta at risk over time.
Going back to the example used in From Theory to Practice, that would mean that a theoretical portfolio collecting $100/day, and $36,000/year, might reasonably expect to capture approximately 25% of that amount, or $9,000 ($36,000 x 25% = $9,000).
For the best possible understanding of this material, we recommend you watch both episodes focused on portfolio theta when your schedule allows.
While the approach discussed above may not fit your strategic approach and/or risk profile, it's all but certain the topics discussed on the two shows will help elevate your thinking.
Returns are of course never guaranteed, and are dependent on specific positions and prevailing market conditions.
If you have questions on portfolio theta or the concepts referenced above we hope you'll reach out at firstname.lastname@example.org.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.
tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”). tastytrade is a trademark/servicemark owned by tastytrade.
Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.
Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information on this site should be considered general information and not in any case as a recommendation or advice concerning investment decisions. The reader itself is responsible for the risks associated with an investment decision based on the information stated in this material in light of his or her specific circumstances. The information on this website is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading in derivatives and other financial instruments involves risk, please read the Risk Disclosure Statement for Futures and Options. tastytrade is an investor in Small Exchange, Inc.