Portfolio Heat
Learn to measure and manage portfolio heat — the total risk your account faces at any moment — before it burns you.
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What Is Portfolio Heat
Portfolio heat is the total amount you could lose if every open position hit its maximum loss at the same time. It is the worst-case scenario for your entire portfolio, expressed as a percentage of your account.
Most traders track individual position risk but never add it all up. They look at each trade in isolation: "This spread risks $400, that is only 2% of my account." But they have 12 of these positions. Worst case, they lose $4,800 — nearly 24% of their account. That is real heat.
Calculating Portfolio Heat
Step 1: List every open position and its maximum loss.
| Position | Strategy | Max Loss |
|---|---|---|
| SPY put spread | Credit spread | $380 |
| QQQ put spread | Credit spread | $400 |
| AAPL CSP | Cash-secured put (with stop) | $800 |
| MSFT covered call | Stock + call (with stop) | $1,200 |
| AMD iron condor | Iron condor | $290 |
| AMZN put spread | Credit spread | $370 |
| IWM iron condor | Iron condor | $350 |
| GOOGL put spread | Credit spread | $400 |
Step 2: Add up all maximum losses. Total max loss: $380 + $400 + $800 + $1,200 + $290 + $370 + $350 + $400 = $4,190
Step 3: Divide by account size. Portfolio heat: $4,190 / $50,000 = 8.4%
This means if everything goes wrong simultaneously, you lose 8.4% of your account. That is manageable.
Heat Limits
Green zone: 0-10% heat. Comfortable. You can absorb a bad week without stress. Ideal for normal market conditions.
Yellow zone: 10-15% heat. Elevated. You are approaching your risk capacity. Do not open new positions. Focus on managing what you have.
Red zone: 15-20% heat. Dangerous. One bad market event could cause a drawdown that takes months to recover from. Start closing your weakest positions to reduce heat.
Danger zone: Above 20%. You are one bad week away from a devastating drawdown. Immediately close positions to get below 15%. No exceptions.
Why Heat Matters More Than Individual Position Risk
You might follow the 2-5% per position rule perfectly and still have dangerous portfolio heat. Here is how:
- 10 positions at 3% risk each = 30% portfolio heat
- If the market drops 5% in a week, you might lose on 6-7 of those positions simultaneously
- Actual loss: 18-21% of your account in a week
This is not hypothetical. In March 2020, the S&P 500 dropped 34% in 23 trading days. Traders who were properly sized on individual trades but had 25-30% portfolio heat saw their accounts cut by 15-20%.
Adjusting Heat for Probability
Not all positions will hit maximum loss simultaneously. A more realistic measure is expected heat — the portfolio loss in a moderate adverse scenario (not worst case, but a bad one).
Method: Instead of using max loss, estimate the loss for each position if the market drops 5% in a week.
| Position | Max Loss | Loss if Market -5% |
|---|---|---|
| SPY put spread | $380 | $250 |
| QQQ put spread | $400 | $280 |
| AAPL CSP | $800 | $500 |
| MSFT covered call | $1,200 | $600 |
| AMD iron condor | $290 | $180 |
| AMZN put spread | $370 | $260 |
| IWM iron condor | $350 | $220 |
| GOOGL put spread | $400 | $270 |
Expected heat in a 5% selloff: $2,560 / $50,000 = 5.1%
This is more realistic than the 8.4% worst case. Use both numbers: worst-case heat for your hard limit, expected heat for day-to-day monitoring.
Managing Portfolio Heat
Add a new trade? Check heat first. Before opening any position, recalculate total portfolio heat with the new trade included. If it pushes you above your limit, either skip the trade or close an existing position to make room.
After a market drop, heat increases. Your positions move against you, unrealized losses grow, and the risk of further losses rises. This is exactly when you should be reducing heat, not adding to it.
Close winners to reduce heat. When a position reaches 50% profit, close it. You reduce heat, free up capital, and lock in gains. This is one of the most effective heat management tools.
Stagger expirations. If all your positions expire in the same week, your heat is concentrated. Spread expirations across 3-4 different weeks so that gamma risk and expiration-week volatility do not hit everything at once.
The Weekly Heat Check
Every Friday, calculate your portfolio heat. Write it down. Track it over time. If you see heat creeping up week after week, you are gradually taking on more risk than you realize. This is how traders drift from disciplined to dangerous — slowly, one trade at a time.
Your heat target should be 8-12% in normal markets. If VIX spikes above 25, reduce your target to 5-8%. When the market is stressed, every percentage point of heat matters more because the probability of multiple positions losing simultaneously increases.
Heat management is not exciting. It is not the part of trading that anyone talks about on social media. But it is the difference between a trader who survives for decades and one who blows up in year two.