Modern Portfolio Theory reduces volatility of returns by combining assets in a portfolio that have less than perfect. How does this relate to options trading?
Maximum theoretical diversification is achieved along the efficient frontier. This is a set of optimal portfolios that offer the highest return to lowest risk. These portfolios are a liner combination of the assets within the portfolio. If assets in the portfolio have a correlation less than 1, holding some combination of the assets is better than only holding one.
Can we construct an efficient frontier using calls and puts to minimize risk?Study Parameters
- Looking at varying combinations of 30 puts and 30Δ calls to minimize variance and maximize returns.
- Returns are calculated using the max margin required for each trade.
- SPY 2005 to Present
Tune in to see Tom and Tony break down the Efficient Frontier using Options!