Option Trading: How important is Asset Allocation. Part I

There have been several recent discussions of the importance (or lack thereof) of asset allocation as a method for reducing risk when investing.  I'm going to offer my contribution to this ongoing conversation.

I consider this to be a topic of vital importance to the economic survival (how's that for drama?) of investors all over the world that I plan to devote several posts to this discussion.

For years, many investment professionals claimed that most of the profits derived from an investment portfolio have been the result of proper asset allocation.  The results of 2008, when essentially all assets got clobbered, has resulted in a rethinking of this time-honored method for investors to reduce risk.  As a professional options trader for more than 30 years, I've been aware that options provide a much better method for risk reduction, but that getting the individual investor interested in learning how to use options has been a difficult battle.  Very much tilting at windmills.

Don-quixote

Tools for the Money, a site that offers financial planning software, says something that contains an aside statement – but that aside is, in my opinion, the key to risk management:  "Asset allocation is the only
non-derivative technique you can use to reduce risk (lower overall
portfolio volatility), increase income, and get better returns, all at the same time. It's the only one of the three ways of managing money that reduces risk." (The other two methods they mention are market timing, and stock selection.) 

They go on to say many wonderful things about the merits of asset allocation, but to me, the most important part of their statement is the acknowledgment that asset allocation is the best method for reducing risk – when one is not using derivatives.

Well, no kidding!  That's the point I've been trying to get across to the investing public – as well as to financial journalists, bloggers and professional advisors.  Derivatives.  Options.  That's the 21st century investment tool required for successful risk management.

Sure, it takes a bit of effort to fully understand options and how they work, but isn't it worth your time to learn how to protect your assets and guarantee that you will never again suffer losses such as those felt by far too many investors when the technology bubble burst in 2000, or the market collapsed in 2008?

I've discussed how to adopt a basic collar strategy – and that is the method I recommend for investors who are joining the discussion at this stage, i.e., looking for something better than 'asset allocation' or 'diversification' to protect the value of a portfolio.

Let's take a look at how others have approached the topic of asset allocation under current market conditions.

to be continued

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2 Responses to Option Trading: How important is Asset Allocation. Part I

  1. tylerstrading.blogspot.com 07/14/2009 at 9:45 AM #

    Mark,
    I’ve noticed you’ve used screen shots of IB before. Are you aware if they allow you to beta weight your portfolio? I’ve done some searching, but to no avail…
    Thanks-

  2. Mark Wolfinger 07/14/2009 at 10:47 AM #

    Tyler,
    No, I don’t know. Sorry. I think your best bet is to ask them directly.
    I know you can export your data to Excel – so it may be easy for you to write your own simple software???