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Options and the Efficient Frontier

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.

Modern Portfolio Theory reduces volatility of returns by combining assets in a portfolio that have less than perfect correlation. 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 30Δ 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!

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