successful option Traders don't just win trades they build portfolios in this video we're going to run through the concepts that most Traders never take the time to figure out or understand before they start building those portfolios such as the portfolio Delta and the overall directional bias that you have with all your positions or the portfolio Theta and the aggregate time Decay that you are collecting or wanting to collect from the market and also what should you be looking for on a day-to-day basis so that you can recognize when things are working and more importantly when they're [Music] not so welcome to our newest crash course how to build a portfolio in four easy steps my name is Jim Schultz and I am very happy that you are here with us today I'm going to try to make this crash course as quick as concise and as worthwhile as I possibly can what we're going to do in these four episodes is we are going to take a bird's eye view of building your portfolio and guys I would argue this is more important than which strangle you're going to sell what stock you're going to trade or which earnings announcement you are interested in so yes this is going to be a four episode crash course super quick and super to the Point here is what we're going to do in episode number one this episode we are going to establish your portfolio goals in episode number two we're going to talk about the power of using indexes first in episode number three we're going to look to add individual stocks and then in episode number four we're going to talk about the daytoday portfolio management so without further Ado let's do it man let's Dive Right into episode number one establishing your portfolio goals okay so step one and this is Mission critical this needs to happen before you place a single trade this needs to happen before you look to put on a single position you need to map out what do you want your target Theta and Target Delta to be at the portfolio level in other words how valuable do you want time to be for you at the portfolio level and how valuable do you want direction to be for you at the portfolio level doing this man it will give you incredible guidance and Clarity with your daytoday decision making what you're quickly going to notice is that every decision you make the new trades the closing trades the position adjustments all these guys can be traced back into these overarching portfolio goals now we're going to talk about each of these Targets in more detail in just a minute but let's take a look at your Theta if your portfolio Theta is too low then you're going to be actively seeking significantly positive Theta opportunities with your new trades this makes sense but what if your portfolio Theta is too high which yes by the way this is a thing then you're going to be more cautious with adding more Theta and instead you're going to be looking for ways to reduce your Theta exposure now what about your Delta are you more bullish than you would like to be well then you'll look to add bearish positions or close bullish positions are you more bearish than you'd like to be then you'll do the opposite add bullish positions and close bearish positions and if you like your Deltas well then you'll be looking for some more neutrally based positions those will be your go-to by determining your portfolio goals at the start like this and then using them as your guide you're able to reduce a ton of subjectivity in your analysis and remain far more objective all right so now let's turn our attention attention to Theta in a little bit more detail and what we're going to do is we are going to look to Target a percentage of net lick or net liquidating value in Daily Theta what this is going to do is it is going to add an incredible amount of context around what this number means and what it can do for us here is what I mean generally speaking we tend to fall in a range of 0.1% to 0.5 % of our net Lick in Daily Theta the number that you see at the very top of your platform numbers on the lower end of the spectrum like 0.1% these are more conservative whereas numbers on the higher end of the spectrum like 0.4% or 0.5% these are going to be a lot more aggressive and the numbers in between of course like 0.2% 0.3% these are kind of middle of the road to put these numbers into a portfolio context 0.1% on a $50,000 portfolio is $50 in Daily Theta where is 0.5% on that same $50,000 portfolio would be $250 in Daily Theta on a $200,000 portfolio 0.1% would be $200 in Daily Theta 0.3% would be $600 in Daily Theta and 0.5% will be a whopping $1,000 in Daily Theta Decay now that we've built a little bit of a foundation for our portfolio Theta we can lean on the tasty research which has shown we can expect to capture about 25% of our daily Theta this accounts for all the big winners all the big losers and everything in between what this is going to do is it is going to give us a great reference point for returns when it comes to our daily Theta capture so assuming 360 days in a year to keep all the accountants happy a 0.1% in Daily Theta would be 36% for the entire year but we only expect to keep a quarter of that so we net out to a 9% return not too shabby and you can clearly see that this number scales with more daily Theta with 0.2% coming out to 18% a year and so on and so forth now some of you out there after having heard that you're kind of licking your chops you're like man this is some really really good stuff and rightfully so I mean positive Theta and daily Decay these are some powerful powerful allies but let's make sure that we all understand something these are just reference points these are just theoretical markers it's never going to be as simple as just putting on your half a percent in Daily Theta kicking your feet up on the desk collecting your 45% returns and then doubling your money every 18 months it's never going to work out out that cleanly which is a perfect segue into our next topic and our next Target Delta so now that we have a Theta Foundation let's turn our attention to Delta and the interesting thing about Delta is there are effectively three different options that you can choose three different Pathways forward through the forest if you will Each of which with its own set of gims and gachas so effectively the first thing you'll need to decide is what directional bias you want to have in the market do you want to be bullish do you want to be bearish do you want to be neutral again a strong case can be made for each of these the market wants to go higher over time and the positive drift in the geometric Brownie and motion asset pricing model effectively ensures that it will so for that reason alone you might want to be bullish but the big high velocity moves in the market usually happen to the downside and these moves generally coincide with with expanding volatility so a short Delta bearish portfolio can be a nice hedge against your short premium option positions and lastly you might want to remove Direction entirely from your portfolio returns which a number of Traders like to do and just be delta neutral you have to choose your own adventure here and any of the three can be successful over time so let's work through how to get started with each bias so if you want to be bullish then I think think a great way to position your portfolio is relative to the Spy index itself here's what I mean for instance with the Spy currently around $450 a share that means that 100 shares of spy is equivalent to about $45,000 that means that if you had a portfolio that was also equal to $45,000 then 100 beta weighted Deltas at the portfolio level would be the same as 100 shares of spy thus you would have a onetoone leverage in your portfolio relative to the index if however you had 200 beta weighted Deltas in that same $45,000 portfolio then you are effectively controlling 200 shares of spy which has a notional value of $90,000 thus you have a two to1 leverage in your portfolio relative to the index as another example let's say you had a $180,000 portfolio here you have four times the notional value of 100 shares of spy so your starting point to have that same one:1 leverage isn't 100 beta weed Deltas or $45,000 that's only a quarter of your portfolio instead it's 400 beta weighted Deltas which has a notional value of $180,000 the same value as your portfolio If instead you had 600 beta weed Deltas that would be a 1 and a half to one leverage ratio itio 800 beta weighted Deltas would be a 2:1 leverage ratio and 1,000 beta weighted Deltas would be a 2 and 1/2 to 1 leverage ratio and so on all right so that's how to think about your portfolio Deltas if you're bullish but what if you're bearish well it's going to play out a little differently let's have a look if you're bearish you could use the same leverage relationships that we established in the bullish context but it's probably even more helpful to think in terms of your Delta to Theta ratio remember guys a big reason that you are bearish in the first place is to protect your short premium and your Theta number is a representation of how much short premium you have so using a Delta the Theta ratio shows you just how much protection you need the key here is to lean on our research and strive for a Delta to Theta ratio of about 1 to2 so one short Delta for every two positive Theta this makes it pretty easy because you already know your portfolio Theta numbers from the work we did just a few minutes ago so with that in hand you can easily figure out your short Delta Target for example if your daily Theta Target is 100 then you're looking for about 50 short Deltas if your daily Theta Target is 500 then you're looking for about 250 short deltas and and so on the great thing here is this already accounts for your portfolio size as that was included in the Theta calculation itself so this ratio can be applied more quickly and universally okay so that's the bullish case and that's the bearish case but what about the neutral case well as luck would have it this guy is actually going to be the easiest of the three so let's have a look with Delta neutrality it's pretty simple you want to keep your portfolio Delta as close to zero as you possibly can now given the fact that we're retail Traders and commissions and transaction costs begin to add up really quickly if we try to Peg our portfolio Delta to exactly zero we can just focus on keeping our portfolio Delta within a range of neutrality anywhere between plus or minus 0.1% of net lick is close enough to zero that we can classify it as pretty delta neutral so for example on a $10,000 portfolio that's going to be a range of plus or minus 10 Deltas on a $50,000 portfolio that's going to be a range of plus or minus 50 deltas and so on if your Deltas move outside of that range then you make the necessary adjustments with both your new trades and your existing positions to bring it back in line it's really that simple so there you have it guys that's how to establish your portfolio goals it's up to you to now decide how to take this information and apply it before I let you go let me give you a couple of points of guidance first you might naturally Be Wondering Jim why didn't you include Vega because when it comes to option returns there's three pieces there's Theta there's Delta and there's Vega well Theta and Delta already cover so much ground that I'm not sure that you're going to derive any incremental benefit from tracking your portfolio Vega as well and not to mention now you also have another metric that you have to babysit you have another metric that you have to Target and at a certain point that becomes significant right at a certain point there's too many cooks in the kitchen and it's difficult to move forward in any meaningful way so that's why you don't see Vega included in this discussion second many of you out there especially you new Traders out there my heart really goes out out to you guys that are just starting out man it's like drinking from a fire hose I totally understand you're thinking Jim I have no idea man I don't even know where it to begin well here is a really great starting point and then you can adjust and customize later on first start with 0.1% of net Lick in Daily theeta it's very conservative you can ramp this up later as you gain experience and you get more comfortable if you want a long portfolio bias which is totally up to you then start with a one: one leverage ratio in exactly the same manner as we went through how to figure that out if you want to be short then just Target a 1:2 Delta Theta ratio these ideas these guide points they will give you a great Foundation they will give you a great starting point for establishing these portfolio goals and then you can adjust and you can customize accordingly As you move forward along the learning curve and and just like that guys we made it through episode number one establishing your portfolio goals whenever you are ready I will see you in episode number two of this crash course where we are going to talk about the power of indexes the power of using indexes first back in episode number one right we kind of built up our foundation looking at portfolio Theta looking at portfolio Delta well what we're going to do now as we look out to build out the specific positions in our portfolio we're going to start to fill in some of the mortar between those foundational bricks so let's do it man let's not waste any more time let's Dive Right In to episode number two The Power of using indexes so the real power behind using indexes it's actually really simple it's going to give you a smoother ride from start to finish basically by definition this has to be the case right cuz when we look at index we're talking about you know S&P 500 you know NASDAQ You Know da and all these other guys these guys by definition are comprised of hundreds and hundreds or thousands and thousands of different individual stocks now forly this difference between indexes and individual stocks is referred to as systematic risk and unsystematic risk in the academic ranks of Finance now keep in mind that these labels are a lot more theoretical than they are practical so for us as Traders we need to slow ourselves down a bit before we attach too much weight to what we have here but nevertheless these are very very useful when it comes to understanding the differences between indexes and individual stocks now systematic risk or Market risk this is the risk that is inherent in simply having some Capital at stake in the financial markets it is UN avoidable and in many ways it's simply a cost of doing business now unsystematic risk or single stock risk is very different this is going to be risks that are unique or individual to that one specific stock therefore they are avoidable and they only become relevant if you happen to have a position on in that particular Equity all right easy enough well let's dive in a little bit deeper and work through some examples of each one of these guys so St starting with Market risk some common examples would be economic data Global growth or lack thereof or maybe interest rates obviously these numbers can have varying impacts and hit some indexes more significantly than others but the idea is still that these risks are spread over the different stocks that make up the index now single stock risk is a little bit different with some common examples being an earnings or report maybe a product or service success or failure or really any major company news these are only going to impact one or a small group of stocks significantly while any stocks that are not directly impacted or related to these events they're just going to go on business as usual therefore by focusing on indexes first before you dive into individual stocks you are only going to be exposed to Market risk so then by definition as a result of that you are naturally going to have or you can expect to have a much smoother ride from start to finish all right fair enough but you might now be asking Jim which indexes should I focus on well let's have a look so let's think about the indexes in three different levels now these aren't formal or official levels they're really just for us but I think it will help to demarcate between the different kinds of indexes so level one these are going to be your major Equity players spy the S&P 500 QQQ the NASDAQ iwm the Russell 2000 and Dia the diamonds or the Dow Jones level two these are going to be your major non-equity players like GLD which is gold like TLT which is bonds like Uso which is oil and SLV which is silver and then lastly level three these could be considered your International indexes or maybe your sector indexes like ewz which is Brazil and fxi which is China and then XLE and xlu and a number of other X indexes that represent different sectors in the US economy now of course this was not an exhaustive list that was intended to represent every single index that you could potentially trade but I do think it's a real reasonable starting point now that you have this lean on this list use this list and turn to all the strategies and the tools that you already have in your back pocket when it comes to stock screening strategy selection or trade entry and if you don't happen to have any tools or strategies in your back pocket then hey let me offer up a Shameless plug for our very first crash course from last fall that will help you do exactly that wow so believe it or not but you already made it to the end of episode number two inside of this crash course some of you at this point however you might be thinking Jim wait a minute what if I don't see enough opportunities with indexes what if I don't see enough opportunities with indexes to hit my portfolio Theta or portfolio Delta goals the very same goals that you showed me how to do back in episode one you know guys it's almost like I've done this before because I had a sneaking suspicion that you might have that question so I suppose I will see you in episode number three adding individual stocks we are going to focus on the role that individual stocks are going to play in your portfolio to this point we've already built up a decent Little Foundation right episode number one we talked about our portfolio targets episode number two we talked about the power of using indexes well now it's time to layer in some individual stocks so without further Ado let's do it man let's Dive Right into episode number three adding individual stocks so as we kind of alluded to on our way out the door back in episode number two there's a really good chance that indexes are not going to be enough there's a really good chance that for you to hit your portfolio Targets in Theta in Delta you are going to need some individual stock exposure that makes sense but before we do this let's make sure that we all understand it we all remember what it is that we've signed up for as premium sellers when you sell an option which is what we primarily do you want its price to fall over time so that way you can buy it back later at a lower price doing this would lead to a profit that is really no different from buying stock or buying an option letting its price increase and then selling it later at a gain selling the option first is just this proc process in Reverse but even more specifically we primarily sell out of the money options so their prices are 100% extrinsic value over time these extrinsic values will naturally be falling as an out ofth money option must sell for zero at expiration so we want to benefit from this with our new positions as premium sellers okay so now that we're all on the same page in terms of what we're even trying to accomplish it's going to be easier to see the power that individual stocks can play the role that they can have in your portfolio if we take a look at one of the most important metrics that we use at tasty trade implied volatility rank so implied volatility rank or ivr is a metric that we lean on heavily and it shows quite literally how the implied volatility for a stock Stacks up against its historical self by taking the current implied volatility of the stock in the numerator and dividing it by the previous year's range in implied volatility the denominator we're able to more accurately gauge where implied volatility is right now relative to where it has been for example let's say that last year's implied volatility range ranged from 10 on the low end to 35 on the high end if the implied volatility right now is at 15 then the implied volatility rank is going to be sitting at 20 the implied volatility is 20% into the distribution of all the implied volatilities from the last 12 months similarly let's say that the implied volatility wereth 30 based on last year's range of 10 on the low end to 35 on the high end now the implied volatility is 80% into its distribution or range from the last 12 months so this would lead to an ivr of 80 okay all that stuff about ivr that's all well and good but why is this important let's look at a couple different reasons first off and quite simply higher implied volatility rank means higher option prices since higher ivr can only happen from higher IV itself and higher IVs into the black Souls model lead to higher option prices out of the model higher ivrs are going to lift option prices this is helpful because remember what we've signed up for guys we want option prices to fall over time so if we can sell them for a higher price cedus parabus then we automatically have more room to work with on the backside but second volatility is a unique metric in that it tends to mean revert over time this means that volatility expansion is often followed by volatility contraction and vice versa therefore entering positions with higher ivrs can put us in a more favorable position to benefit from volatility mean reversion a word of caution here though while volatility has been reliably shown to mean revert we never know when it's going to happen it can remain extended longer than we can hold on all right Jim I have to admit man couple minutes in and you've sold me on this High ivr situation so where can I find some high ivr opportunities well let me give you two really good resources first up the pre-populated watch lists on the platform are excellent tools to start with here the default watch list or even Tom's watch list will give you a pre-screened list of all the stocks you see us trading day in and day out sort these watch lists by ivr and you will be in business but second earnings earnings for publicly traded companies come around every 3 months and generally speaking earnings tend to lift the IVs or the ivrs of stocks as Traders bid up option prices in anticipation of potentially explosive moves thus these are a great time to establish new short premium positions just be careful as as these big moves can make earnings a tougher go than more regular trades but it's still worthwhile to check these out to see if anything jumps out at you you now again use indexes first right like lean on what we talked about back in episode number two and use the indexes to begin to populate your portfolio but there's a really good chance that you're not going to get there you're not going to get to your portfolio targets with indexes alone so this is when individual stocks come into play now naturally some of you all of you especially you beginner Traders out there you're thinking at this point like all right Jim like you nudge me in the right direction when it comes to implied volatility when it comes to IND idual stocks but man you left a lot to be desired when it comes to the specifics when it comes to the Strategic detail around how to actually execute these trades that is 100% correct and the reason why I did leave a lot to be desired here is go back to crash course number one and crash course number two both of which are already available on our YouTube channel and we went through all of that in very very fine detail so be sure to give those guys a look if you haven't done so already and man just like like that almost like it didn't even happen episode number three of the how to build the portfolio crash course has come to its natural conclusion I will see you in the final segment inside of this crash course episode number four the daytoday management of your portfolio we've already talked about your portfolio targets we've talked about using indexes we've talked about adding individual stocks here in episode number four we're going to talk about arguably the most important part the daytoday management and my hope is that after this episode you guys will begin to see how everything comes together so let's do it man let's Dive Right In to episode number four of the how to build a portfolio crash course the daytoday management all right so the day-to-day management it really boils down to One Singular thing you need to identify problems if your strategies are working doing nothing is almost always going to be the move like if things are going well like sitting on your hands and unplugging your mouse is almost always going to be in order but naturally there are going to be times maybe on a daily maybe on a by daily basis where things might not be going as swimmingly as you might have hoped so here you need to identify the problems and specifically you need to differentiate between problems at the position level and problem S at the portfolio level so position level problems these are usually going to be pretty obvious like they're going to jump off the screen and stick out like a sore thumb they could be a huge move in the stock could be a situation where one of your strikes has been breached or maybe you've just naturally reached the 21-day marker in that cycle sure some of these are going to be a bit more surreptitious like you know your index individual stock exposure but usually you won't have to go hunting around to find these guys they're going to find you now with your portfolio level problems these should also be fairly clear mainly because you took the time to establish your portfolio targets at the very beginning are you too directional do you have enough Theta working for you do you have too much Theta working for you these are all going to be common questions that you're going to find yourself asking yourself as you are viewing your portfolio knowing what you're trying to accomplish with your Delta and with your Theta will allow you to see very easily when things are off Target okay so now that we've got our bearing set and we know what it is we're even trying to accomplish when it comes to day-to-day management let's dive deeper back into the position level first off it's important to mention that we've already built an entire crash course around strategy management with the ins and the out of how to adjust our most popular strategies so I'm not going to regurgitate that here instead I want to offer more of a bird's eye view of your portfolio as it pertains to defined risk strategies and undefined risk strategies okay so starting off with your defined risk strategies these are going to be you know your short put spreads your short call spreads your iron Condors Etc these are going to be pretty hands off a lot more l Fair where you just let the trade go and you give the probabilities room to breathe either you take the trade off at your profit Target or you end up absorbing a loss now could you adjust these sometimes yes but that's more of an in-depth discussion that we're not going to have here because if we did I would be front running myself before the next crash course that is slated to follow this one so stay tuned for that now with your undefined risk strategies you know your short puts your strangles your ratios Etc this is where all the subtlety and Nuance is going to start to show up right any adjustment Wizardry or management magic is almost always going to materialize with naked positions now again check out the strategy management series for more of the Tactical moves that you would actually make but generally speaking from a problem identification standpoint which is our goal here remember it's pretty simple if you're out of the money you do nothing once your strike is hit and things move in the money that's when you act if you're before 21 days to go you do nothing once you get to 21 days to go then it's time to move then it's time to act all right so those are the Frontline actions that you're going to want to take at the position level which I would argue should be addressed first if for no other reason than these guys are usually going to be very very obvious but still we have some portfolio level problems that need to be addressed so let's have a look so once all of your individual positions have been taken care of and any and all necessary adjustments have been made here you turn to your overall portfolio at the same time it might not be a terrible idea that as you're making the necessary position adjustments you have an eye on your portfolio targets that way when it's a close call as to what you should do kind of a toss up either way you can defer to those portfolio targets but if there's ever a disagreement between the portfolio level and the position level then the position level pulls rank like for example let's say you need bullish Deltas at the portfolio level but a given position is far too bullish and you need to add some bearish Deltas to balance it out here you want to let the position level be your guide first and foremost the reason why is that there is only one way to to adjust a given position's situation it's through that given position but with your portfolio as a whole you can always find new trades and establish new positions to adjust your overall levels too then once each position has been adjusted you can look to add new positions to adjust your overall portfolio goals which is pretty straightforward you need positive Delta you add trades with a bullish bias you need more positive Theta you add trades with positive Theta probably of the undefined risk nature so that you can build up Theta more quickly you have too much positive Theta hey you can close some of your existing trades also probably undefined risk or you can add new trades that are more Define risk so their Theta impact won't be too significant couple of things to keep in mind moving forward with this information number one don't feel like you need to nail your portfolio at Targets every single day if they're off just a little bit and it takes you a couple of days to bring these things in line it's unlikely that that's going to be a real big issue but number two at the position level you should be able to achieve your desired outcome in terms of directional bias in terms of theta in terms of whatever it is you're trying to accomplish with that one specific position you should be able to do that in the moment you should be able to do that in the here and now it shouldn't take too long for you to course correct that one individual position wow and just like that ladies gentlemen we are done we are done with episode number four we are done with the entire crash course I really hope this gave you guys some new ideas and when you are ready I will see you in the next crash course which I don't know when it's going to be ready but when it is I hope I'll see you there