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Building a Core Portfolio

Dec 19, 2016

By: Josh Fabian

When it comes to creating a sizable portfolio, investors have multiple directions from which they can choose. Contrarian traders look for products trading near their highs, then sell them short. At the other end of the spectrum, they stock up on products considered, “out of favor.” Why? Because contrarians believe in cyclicality and want to profit when things turn. They may be early at times, but a stiff drink can help with that.

Product Selection

Products being considered for a portfolio should be liquid. Entering and exiting a trade needs to be simple; no "Hotel California" scenarios. Also, the products selected should offer options to allow for hedging. With an account of $250,000, one way to allocate capital might involve something like the following:

This portfolio is using $250,000 of buying power with a notional value of just under $725,000 amongst several products. Positions are also being established based on a contrarian methodology.  

Selling Premium

A core portfolio consists of positions against which premium can be sold. Selling premium helps improve cost basis. It hedges positions by reducing exposure. It also can create greater returns on capital. Hedging the above portfolio with options premium might look like this:

The options sold against the core positions in this portfolio take in just over $7,400 in premium. If all those options were to expire worthless, the entire $7,400 is kept as profit. However, tastytraders manage trades, usually around 50% of max profit.

Beta-weighting Deltas

Beta-weighting deltas in a portfolio against a product like SPY (S&P 500) helps quantify a position and/or a portfolio. Those deltas translate into an equivalent number of SPY shares. This portfolio has a beta-weighted delta equivalent of -1180 or, the equivalent to being short 1180 shares of SPY. This helps in understanding market exposure.

Net Net

A core portfolio is like owning a house. Over time, hopefully, it will appreciate in value. Until it is sold, improvements can be made. Selling options and taking in premium is similar to remodeling a bathroom. At the end of the day, the improvements made create greater returns on the initial investment.  

Josh Fabian has been trading futures and derivatives for more than 25 years.

For more on this topic see:

Top Dogs: Managing a Large Account - December 12, 2016

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

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