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Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT... More
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  • Can Options Replace The Need For Diversification? 3 comments
    Jan 1, 2013 3:06 PM

    We have all been cautioned since the first time we thought about investing, that we must diversify. You cannot invest in any one issue or even market, because the risks are too high.

    Are they really?

    What if your investment strategy is to seek 4% dividend yield? Would it be all right to put all of your capital into stocks yielding 4% or more? Many will say no, that this by itself does not diversify your portfolio. I disagree.

    There are hundreds of stocks yielding over 4%, which is indisputable. The problem arises when market risk is brought into the picture. This is where you need diversification, including picking up shares of some companies that yield low dividends, or no dividends. Here again, I disagree.

    Imagine a strategy not based on capital gains and buy-and-hold strategies of value investments. If you would be happy with annual yields of 4% or more, you can accomplish that by buying shares of only those companies yielding in this range. Consider, for example, Altria (MO), AT&T (T), Verizon (VZ) Eli Lilly (LLY), Avon (AVP), ConocoPhillips (COP), Credit Suisse (CS), or Lockheed Martin (LMT) - a small sample of about 750 companies yielding above 4%.

    But what about market risk?

    Options for Risk-Free Portfolios: Profiting with Dividend Collar Strategies

    If your intention is to focus on 4% or more annual income, focus on dividends and hold stock in a risk-free environment. Use collars to prevent losses on the downside, while being willing to accept exercise if prices move above the short call's strike. If that happens, pick one of the other 740 stocks and continue with the plan. This "dividend collar" is a worth one to think about. You might have to enter it in legs because finding the right prices is not easy. For example, if you have you have appreciated shares in your portfolio, the dividend collar is a perfect strategy for locking in current profits paying for that insurance with a short call, and earning the current quarter's dividend.

    It's a strategy worth thinking about, especially if you have been relying on guesswork and timing to make money on stock positions or to speculate on options. Use those options to reduce risk while protecting basis, all to create a nice 4% or more return every year.

    With that working for you, who needs diversification?

    I have a new book coming out on this very topic, being published early next year by Palgrave-Macmillan. I hope you will look for this book on ThomsettOptions.com or order it on Amazon.com. The link to the amazon site is Options for Risk-Free Portfolios - this is a big subject but there are many ways to build profits in a safe environment and with the use of an options-based strategy.

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  • Thomsett
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    Comments (135) | Send Message
     
    Author’s reply » Is diversification always necessary?
    1 Jan 2013, 03:07 PM Reply Like
  • Rookie IRA Investor
    , contributor
    Comments (2537) | Send Message
     
    Yes, good points. If you wanted a 4% return, without using much leverage you could sell BRK.B put spreads ($90/$45 for example) for an annual return of about 12% and keep the other two thirds of your net account in cash or US bonds funds, and still get a total return of 4%. Your investment would not really be lacking in diversification. The exact rate of return might depend on the current VIX rates.

     

    Of course in the event of a complete collapse in the price of BRK.B stock, you might lose 1/3 of your net worth, but on the other hand if BRK.B collapsed to that extent, do you really think your other investments would be doing any better?
    1 Jan 2013, 05:21 PM Reply Like
  • Thomsett
    , contributor
    Comments (135) | Send Message
     
    Author’s reply » I agree. There are dozens of ways to use capital to make good return and at the same time hedge risk. Diversification is for those traders who accept risk as inevitable, a myth perpetrated by "professionals" who need clients to rely on them. - Michael
    2 Jan 2013, 08:44 AM Reply Like
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