Market Measures

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Diversifying Equity Short Premium

Market Measures

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Following up from yesterday’s Options Jive concerning diversifying by implied volatility, we performed a study looking into the historical success of diversifying a short premium portfolio by the correlation of the underlyings’ IV. The market that is currently exhibiting the weakest correlation to the S&P 500 (SPY) both by price and IV is that of the Euro (FXE); thus, FXE currently poses the best diversification option for short premium trades in SPY.

The Results

The backtest was run from 2010 to present, exhibiting the results of selling Straddles in both SPY and FXE. The crux of this study is in what has historically occurred when SPY Straddles have lost, since a positive P/L in FXE straddles in this scenario would present the diversification that we are looking for when trying to diversify our short premium portfolios. Historically, our results showed that FXE Straddles usually performed the same or even better when SPY Straddles showed losses. This, Tom proclaims, is the reason why he keeps positions in multiple markets other than just that of the equity market. That is, though a Straddle in FXE may not net you as much in credit received as a Straddle in the Russell or Apple, we keep those positions on to lessen the sting of losses in our equity short premium.

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