Portfolio diversification is important; we don’t put all our eggs in one basket. Correlation is one way that we, as tastytraders, can assess our portfolio's diversity. When products move similarly, we refer to them as correlation. For example, indices tend to move together and have strong positive correlation while indices and gold move inversely with semi-strong negative correlation.
However, correlations can diverge or converge over time. When indices fall, correlations tend to increase, which makes diversification more difficult. This led us to ask, how can we properly diversify if correlations converge to 1 when markets are selling off?The Study:
- Tested correlations of products against SPY during three recent turbulent market periods:
- Second Half 2011
- Second Half 2015
- January 2018
- Determined which asset class provided the most robust diversification.
- Indices, Interest Rates, FX, or Commodities.
Many assets move with the market during sell-offs. The products that offer the most robust diversification are bonds (TLT) and gold (GLD). Trading different symbols and strategies improves diversification to create a portfolio that benefits from all types of market movement.
Tune in as Tom and Tony expand on these results and explain what types of options strategies they look to use in these various assets.