Minyan Mailbag: Money Management
Any strategy should have either an edge or a known and accepted reasonable risk.
I heard a presentation today from a guy who uses my current investments as a "base" which serves as margin and then sells put spreads to enhance the return on my portfolio. The porfolio can consist of anything from bonds to preferreds to mutual funds. The spreads are well out of the money and so, have "low risk." This is supposedly the only guy in the country doing this for individual accounts.
I would, of course, like to get the bump on my investment return but I am (perhaps too) painfully aware of the risks of option selling, particularly in the market in general, thanks to you and Minyanville.
I was hoping that you might have some comments on this.
Thanks for everything you have done for me and the 'Ville!
This is perhaps the worst strategy I can imagine.
There is risk in doing this. In fact, the risk is priced to be not in your favor. Any strategy should have either 1) an edge, a misvaluation to take advantage of. This is an "arbitrage strategy." Or 2) a known and accepted reasonable risk for a reasonable return such as an asset allocation strategy.
This has neither. In selling put spreads, you most certainly do not have a price advantage; in fact, you have most likely a disadvantage. In most cases, the more out of the money that a put is (the one you are buying relative to the one you are selling), the more expensive on a relative basis it is. In the event the put you are short goes in the money (losses), the out of the money put you are long for protection usually does not go in the money and provides none. So from both a pricing basis and a practical one, this is not smart. Your broker buys that put so that he can tell you he has defined risk. In reality, he is paying too much for insurance that is like what most people found in Louisiana...it is worthless. Secondly, selling put spreads is a disassociated "kicker" to your already incurred exposure or risk.
This is unacceptable and dangerous fiduciary behavior.
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