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business newsOptions to Boost Your Returns
Building discipline, balance and profit.
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I'd like to talk about how options can be worked into your trading and investment portfolio to boost your overall returns.
Specifically, I’d like to talk about diversification and asset allocation. You're most likely familiar with the broad general rules of asset allocation, such as a mix of stocks, bonds, real estate and commodities. So let's move on to the next level and get straight to how options can fit into your overall investment and trading goals.
Depending on your age and total available assets, you should allocate only 10% to 20% of your total risk capital to an options-based portfolio. Let's assume you're fairly financially secure and can commit $100,000 to a strictly option-based trading account. Right off the bat, I'd say that one should typically have only half of that figure ($50,000) at work at any given time.
A Question of Balance
Of that $50,000, about 50% ($25,000), is dedicated to hedged positions -- such as spreads -- that have both a limited risk and limited reward. These may be simple vertical spreads, or more complex calendar and butterfly strategies. About 30% ($15,000), is dedicated to longer-term, directional positions.
And given the type of sell-off that's occurred in recent months, remember to balance both bullish and bearish positions. At minimum, keep some index puts in place -- whether they be on the Nasdaq 100 or its ETF, the Powershares 100 (QQQQ), or the S&P 500 in the form of the Spyder Trust -- to maintain broad-market downside protection. Figure you can allocate about 5% of the option portfolio toward keeping an inventory of index puts to maintain broad-market protection.
Taking a Shot
Finally, you can keep about 5% to 10%, (about $10,000), available for purely speculative positions, which might consist of using out-of-the-money options on earnings plays, takeover targets, or news events.
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