Sizing Correlated Positions Together

You own five regional bank stocks, each at 3% of the book — comfortably under a 5% single-name cap. On paper this looks diversified: five separate ideas, five separate stories, five separate risk budgets. In a rate shock or a regional-banking liquidity scare, all five move together, and what you actually hold is one 15% position in "regional bank stress," sized as if it were five unrelated 3% positions because nobody added them up.

The cap that catches what per-name caps miss

Per-name concentration caps are built to catch a single stock blowing up. They say nothing about a shared driver across several stocks that individually look small. The fix desks use is a cluster or theme cap: group positions by their dominant common factor — sector, geography, a shared supply-chain input, exposure to a single commodity or rate — and apply a separate, tighter limit to the sum of the group, independent of how each member scores against its own single-name cap.

The grouping is a judgment call, and it is worth erring toward grouping too aggressively rather than too loosely. Two stocks do not need to be in the same GICS sector to move together; a memory-chip maker and a construction firm can both be levered bets on the same interest-rate path even though nothing about their business description says so.

Worked example

Single-name cap is 5% of a $150m book ($7.5m). A trader holds five regional bank longs:

Name	Size	% of book
Bank A	$4.5m	3.0%
Bank B	$4.5m	3.0%
Bank C	$3.0m	2.0%
Bank D	$3.0m	2.0%
Bank E	$3.0m	2.0%
Cluster total	$18.0m	12.0%

Every single position clears the 5% cap comfortably. If the desk's theme cap for "regional bank / rate-sensitive credit" is 8% of book ($12m), this cluster is 50% over its real limit even though it never triggered a single-name alert. The correction is to trim the cluster as a whole — likely dropping the two lowest-conviction names entirely rather than shaving all five, since a thin trim across five correlated names barely reduces the shared exposure that actually matters.

Building the check into the routine

This is not a one-time exercise at trade entry. Correlations between names you did not think were related can rise sharply during stress — the "everything correlates to one" effect — so the cluster check belongs in the same regular book review as the stale-position review, not just at the moment a new position is added.