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Market Measures

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Diversification: Direction vs. Neutral

Market Measures

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

Correlation is used to gauge how similar two markets are; for the sake of diversification, we want correlations near 0.

If we take a look at some popular ETFs and compare them to SPY, we find that they have high price correlations. But the correlations of options to SPY are much weaker, thus provide much more diversification.

Another way to think about this is if you have an underlying that is highly correlated to SPY and you want some diversification from your equity portfolio, consider trading an option in that underlying because the P/L from that option will be much less correlated to your equity portfolio than the outright underlying.

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