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Can You Beat the Market? Part 4


Portfolios look better in collars.


Editor's Note: This is Part 4 in a multiple-part series. Part 1 can be found here, Part 2 can be found here, Part 3 can be found here, and Part 5 can be found here.

The results are in for the buy-write indexes, but they're far from definitive.

Writing covered-call options on a basket of stocks that mimic broad-based indexes is a reasonable play. But I can't conclude that it's a strategy that always makes extra money.

What is true, is that covered-call writing:

  • Reduces portfolio volatility (good)
  • Enhances profits for a portfolio of large-cap stocks (good)
  • Provides mixed results for more volatile stocks, such as those in the Nasdaq and Russell 2000 (not as good)
  • Under-performs during strong bull markets and out-performs otherwise (as expected)

Personal note and a chance to vent: I have a bias toward the adoption of collars by a large segment of the world's investors. That's why I want to see results that demonstrate that collars are a viable investment strategy, and not too costly.

Most investors use the buy and hold strategy because they don't know any better, take the advice of professional advisers who are more concerned with their own commissions than with the best interests of the client, or just follow advice they read in the newspapers or find on many financial blogs.

I'm not saying that buy and hold is always a poor idea. I have no problem with it when it's the investor's own decision. But it's not okay when it's based on listening to someone who has a vested interest (commissions) in telling you to hold stocks forever and continue to buy more. None of these investors is Warren Buffett and it's not a good idea to attempt to do what he does.

Proof that investors make poor investment decisions is the trillions of dollars invested in traditional mutual funds. These are funds which can't perform as well as the market averages, but are not bashful about collecting management fees for that under-performance.

Many such funds even charge a sales load (I shudder at the thought of people wasting money on extra commissions) to be allowed to buy funds that, on average, under-perform index funds. It's a shame that so many investors never learned how to invest. Avoiding mutual funds should be the number one lesson. Okay, end of rant.

It's appropriate to look at collars in our search for methods that beat the market.

The collar is a covered call, but it also includes the purchase of a put option. Those puts are costly, and comparing portfolio performance for a collared portfolio against the same portfolio (un-hedged, or buy and hold) should give investors an idea of just how much it costs to protect a portfolio against losses.

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No positions in stocks mentioned.

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