I'm trying to see what would be a feasible approach to capital allocation on options trading for an individual investor and would appreciate anyone's input on the subject. Say you have $x that you want to use for options trading and you want your portfolio to include, for example, straddles, calendars, naked puts and/or others. Presumably you would want to allocate capital in a way that you are not over exposed to any particular strategy, understanding that under different market conditions you might favor certain strategies over others. As an example: trade at 90% of account value (leaving 10% non-applied cash for safety). The 90%, whatever that amount is, you could use 30% margining of naked puts if you decided to trade those (to be more conservative, let's assume that also includes a cushion on top of the broker requested margin), 25% straddles, 25% calendars, and etc. Does anyone manage their portfolio that way? Do you have different methods for capital allocation, for example do you look at your cumulative portfolio greeks and work from there? Thanks for sharing your views
My 2 cents is what's feasible is what's working. I don't think that it's too hard to figure out what strategies are doing better and shift one's bias in that direction. AFAIK, avoidance of excess leverage and good money management are of greater importance than an allocation flow sheet. Be flexible rather than adhere do strict guidelines. For example, would it be a good idea to do 25% naked puts and 25% ATM calenders during a GFC meltdown ala '07 to '09? Or would it make sense to be biased short?
You could allocate according to some Market signal, or a group of signals in combination to allocate. A complete allocation strategy should address these issues: Timeframes - what is your exposure in various timeframes Event Risk - exposure to single events, sector events, and Market events at various timeframes. Directional - Long / short / neutral Sector - allocation to trends/ or mean reverting/ considering the momentum of sector, this is also referred to as concentration risk Correlation risk - what happens when the payoff for a trade or a series of trades deviates from norm, how will the allocation hold up Moneyiness - (how far in the money/out of the money) & (how aggressive the allocation acts in anticipation of Market signals) Liquidity - (how likely you are to be filled in your options & associated slippage) Concentration risk
I tend to divide things in my brain into directional and nondirectional. The various markets are either going to assume a direction or not. If a market does assume a direction, it may be either direction--the right one or the wrong one. In almost all months, I have some nondirectional trades. These I think of as positive or negative or neutral in terms of vega. There may be some of each. Some of the time I also have some directional trades. Among the directional ones, there are, of course, unidirectional ones like bull or bear spreads, and bidirectional ones like long straddles. So I try to figure out how much I will lose under various outcomes and allocate things so that the result will be palatable under any scenario. I do make some guesses about direction and volatility, but I try not to get tilted too much in one way, since I am wrong a lot. All with mental stops.