Tastylive: Why We Don’t Believe in Modern Portfolio Theory in 2025
Investors have many ways to think about the market. Most investors follow modern portfolio theory (MPT). First developed in the 1950s, MPT looks at the market as a way of transmitting information.
When new information about a company comes to light, the news is immediately priced into markets. Consequently, MPT investors look at a market that is efficient, and challenging for investors to beat over time.
However, in reality, this theory is incomplete. It assumes that all traders are rational at all times. But we know that human beings are capable of decisions based on fear and greed. When that happens, markets may get oversold or overbought at times.
Today’s traders have more tools than ever to take advantage of those periods of extreme emotion. By leaning against markets at an extreme, they can make excellent returns.
Options trading can allow traders to hedge their portfolios in overly bullish markets. That could include selling covered calls against existing portfolio positions. Or it could mean buying put options to hedge against a big market swing lower.
Either way, markets generally look efficient on a daily basis. But markets are also more quick to react to events with the rise of options trading swinging the markets. Astute traders can pay attention to these swings and use them to profit.
