The Submarine Method of Managing Your Portfolio Risk




The Submarine Method of Managing Your Portfolio Risk’s Director of Research Michael Gross explains the “Submarine” method of managing overall portfolio risk in option selling.Learn how to manage risk in option selling if you are selling put options or selling call options when investing in commodities

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(Video Transcript)

Hi, this is Michael Gross, Director of Research at This is your bi-monthly Option Sellers Video Lesson. The subject of this week’s lesson is The Submarine Method of Managing Risk in Your Portfolio. The Submarine is a nickname we’ve given to a method of managing your overall portfolio risk. If you remember from last week, actually it was last month, we did a piece on managing individual position risk. The second part of risk management is managing overall portfolio risk, which is a very important aspect of an option selling portfolio because in an option selling portfolio most of your positions are going to be successful. Most of your positions are going to do what you want. They’re going to either slowly decay and expire worthless or they’re going to decay a little more quickly and you’re going to buy them back at a profit. The entire key of your results at the end of the year in your option selling portfolio is going to be based on how you manage the 10%, 15%, 20% of the positions that don’t do exactly what you want. If you manage those correctly and efficiently, you take a big step towards getting the results that you want. So, that’s what we’re going to talk a little bit about today.

Before I get started, if you are interested in what we talk about today or some of the things we’ve talked about in our other videos, we cover all of this thoroughly in our book, The Complete Guide to Option Selling: Third Edition. The Third Edition came out through McGraw Hill and you can order it on our website at a 40% discount off the cover price. If you are interested in getting that discounted copy, you can get it at So, let’s get to The Submarine Method of Managing Portfolio Risk. I’m going to do a diagram here. One of my favorite movies is the movie Crimson Tide. It’s a movie that came out, I believe it was in the 90’s, that has Denzel Washington, Gene Hackman, great movie if you love submarine movies. Premise of the movie is there’s a power struggle between the captain of the ship, Gene Hackman, and the, I believe they call him the XO, which is Denzel Washington. Without going into the whole summary of the movie, Denzel has control of the ship at one point. They’re under attack by an enemy sub. They do take a hit, okay? There’s a hole and the submarine takes a hit right there. Now, on a nuclear submarine, it’s divided into many different compartments. Each one of these compartments can be sealed off from the rest of the ship. There’s a hatch here, so, if it takes a hole in one part of it these hatches can be sealed, the ship stays afloat, the ship doesn’t sink because it has still got the other hatches in tact.

This is the exact model we use for managing risk in an option selling portfolio. If you’re serious about selling options in a portfolio, it may be one you’d like to consider, as well. This is why. Our structure for this portfolio looks like this. This circle is your portfolio. If you’ve seen our books or seen any of our materials you’ve seen this circle before. This is how we recommend approaching or structuring your option selling portfolio. 50% of the portfolio, most of the time, we recommend keeping it in cash. If you trade stocks, you’re a stock option seller, this may sound strange to you, but as a commodity options seller it should make a lot of sense. Commodities options are automatically leveraged and your margin requirement, while typically don’t vary greatly, they can vary based on the movements of the market. So, you want to keep a big cash cushion here to be able to account for that if you don’t want to get out of your positions. If you’re getting out of positions, you want to be getting out because they hit your risk parameters, not because a margin is fluctuating, so you want to keep a big cushion of cash. It also helps keep you from over-positioning, which is another mistake that new option sellers make. You kill two birds with one stone by keeping a big cash cushion. It’s one of the top things we recommend to option sellers.

So, what do you do with this other 50%? The other 50% should be diversified over a basket of different commodities. What do we recommend? Typically, somewhere between 6-10 different markets, so you might have corn, you might have wheat, you might have silver, you might have natural gas, you might have coffee, you might have crude oil, you might have orange juice. There’s a number of different markets you can have there and you can be short calls or short puts, so you can be bullish or bearish in a different variety of them. This accomplishes the same thing that the submarine does. Let’s think of your submarine again. Separate compartments, same thing here. Separate compartments. If one takes a hit, it doesn’t blow up the rest of the ship. That’s what you want. That is how you manage risk in an option selling portfolio based on overall risk to your portfolio. That’s your structure.

Now, what benefits does this provide to you as an investor? Well, it provides several benefits. The first benefit, it gives you a more risk averse portfolio, and not only risk averse, but it gives you a layer of protection against the dreaded black swan. This is something that stock option sellers ask me a lot about because stock option sellers, even a diversified stock option portfolio, they’re still all in stocks, so a black swan event comes along that affects the whole stock market, that’s affecting your whole portfolio typically in a big kind of way. When you’re using the submarine type of risk management approach in portfolio structure, in commodities options you’re in 8-10 different uncorrelated markets, so hit the one theoretically doesn’t blow up the portfolio like it might in a stock portfolio where a big hit to the index can have a major impact on your portfolio. So, it gives you some insulation against the black swan.

Number two, stability. By keeping small positions spread out across a widely diversified portfolio, it gives your portfolio stability. Again, it goes back to the risk aversion. You have small positions in different uncorrelated markets, a big hit to one doesn’t affect the entire portfolio to a great degree. That’s the theory. The third benefit to you is peace of mind. You don’t have to worry as much about the black swan. You don’t have to worry as much about being on that roller coaster ride. Theoretically, using this type of portfolio structure, you’re going to have more of a streamlined equity curve, which is what a lot of investors are after. Often times, getting the result you want at the end of the year, while important, sometimes how you get there is just as important. Making 25% might not be as much fun if you spent half that year up at night trying to figure out what you’re going to do with your losing positions, or you were down 50% then you were up 50%. Those type of swings typically aren’t what an investor who just wants to grow his capital is looking for. So, what this type of portfolio structure is going to help you achieve is a little bit more streamlined in that streamlined equity curve, which is what most investors are after and I’m guessing you are, too.

I hope this week’s video lesson has proven helpful to you. Again, if you would like to learn more about structuring your portfolio or more lessons on selling options in the commodities markets, we do recommend our book, The Complete Guide to Option Selling. You can get it on our website at Have a great month of option selling and we’ll talk to you in two weeks.

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