Managing an options portfolio

When managing any portfolio of assets, risk is to do with change. If circumstances never changed, there would be no risk. The basic idea behind risk management is to prepare for change. An options portfolio is no different in this regard and managing an options portfolio means being aware of how the position’s character will change when circumstances change. There are several main drivers of change to the value of options. Managing an options portfolio means understanding and responding to those drivers constantly.

The main drivers of change / risk factors to an options portfolio

 A change in the price of the underlying (spot) product

A moving spot product changes the risk profile of options. Options can move from being out-of-the-money to at-the-money to in-the-money and at each stage their risk characteristics alter. Whilst the immediate threat to an options portfolio from a change in the spot price can be hedged away using the spot product (i.e delta hedging), the risks can be more complicated than this. For example, a far out-of-the-money option may have very low levels of option risk (as reflected by the Greeks). But if the spot moves and this option becomes at-the-money, then the risk can be very much higher. Furthermore, this risk may not just involve delta risk but could include other Greeks, such as vega and gamma.

A change in implied volatility

Another key driver of risk to the options portfolio. Implied volatility movements can directly affect the value of options. Option value is positively related to implied volatility changes. So for options whose strike is not too far away from the current spot price, falling implied vol will lead to a fall in value. Managing an options portfolio means understanding this risk and formulating a strategy to deal with the possible outcomes. This might for example include hedging the risk using other options.

The risk to options from time passing

In escapable risk factor to any options portfolio is the passing of time. Most options have fixed expiration dates meaning their lifespan is finite. As time passes, their value will typically change to reflect this. Other things being equal, the value of options diminishes as time passes. Managing an options portfolio means dealing with this risk appropriately. Measures might include gamma hedging to offset the risk. Or again, hedging the portfolio with other options to minimise the risk.

Combinations of the main risk factors

Of course, if options portfolio management was as simple as understanding the above risks and acting on them, option risk would be relatively easy to deal with. In practice, these factors will often occur in combination. So, the spot price might move aggressively AND the implied volatility also moves. Or time passes and the implied volatility moves etc. Learning how to manage an options portfolio means understanding these dynamics in several dimensions. There are lots of potentially moving parts and each part can drive another. This may appear to be an impossible task, but as with everything it just requires practice. Why not use a great options market simulator to practise and learn how to manage an options portfolio?

Bottom line

Managing a portfolio means preparing for change. Several main factors can affect an options portfolio and managing the portfolio means understanding and dealing with these factors. The main factors can often work in combinations meaning the risk management can take on several dimensions. There are also several minor factors which often drive change in the options. But the main factors are those that the option trader must deal with on a constant basis if he is to be successful.


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