An important aspect of trading and portfolio management is diversification. If all your positions have similar exposure and the market moves in one direction your positions will move together. One way we attempt to remove this systemic risk is by trading a variety of strategies on unrelated underlying’s. But can option strategies on their own provide diversification?The Study:
- SPY – QQQ – IWM – DIA
- 2005 – Present
- 16 Delta Strangles
- 45 Days to Expiration
- Compared Correlations in Strangle P/L Across Index Products
Looking at the four major stock indices in the United States, we see that both their prices and implied volatilities move together. Additionally, if we trade the same strategy on these similar underlying’s we see that strangle performances move together. Premium selling alone does not provide portfolio diversification. However, one way we can gain diversification is through trading different strategies on unrelated products.