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Top Dogs: Managing a Large Account

Improving Your Odds With Options

Top Dogs: Managing a Large Account

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

This is the first part of a six planned episodes updating our original "Top Dogs" series. This segment lists the planned shows in the series, introduces the idea of establishing a portfolio and, most importantly, explains the advantage of making smart use of options. Many money managers charge a 2% fee on assets under management. We believe you would be better off taking control over your own finances. We will give you the info that can help you to succeed.

We ran a study using 6 most liquid ETFs: SPY, IWM, QQQ, TLT, GLD, EEM in a hypothetical $250,000 account. Each ETF was given equal weighting and we created all the possible combinations. Each portfolio was charged a 2% “management fee”. Since last year the average portfolio lost $5000. The best performing portfolio was up $25,000 and the worst down $35,000. Modern Portfolio Theory states that we should choose minimally correlated assets. The idea is that as a group the assets should prove to be less risky and have less volatility. A table of correlations made clear, that all the stock index ETFs were well correlated to each other. Gold, Bonds and the Euro FX were not well correlated to each other or the stock indices.

Dividing into three portions, the time between 1987 and the present, we see that the stock indices have become increasingly more correlated to each other over time, including Emerging Markets (EEM). Another table revealed the correlations between the stock indices of the global markets. The correlations are high so diversifying across different countries provides little help. "The World is Flat when it comes to global diversification."

A final table displayed the benefits of using options. A strategy of short Puts or Covered Calls using the 30 Delta was superior to a simple long strategy using SPY. The mean and median averages as well as the percentage of weeks that were profitable were higher and the Standard Deviation (SD) of yearly returns was lower. A graph of average annual returns versus their SD showed how this is what we should expect. Using options can improve returns, reduce cost basis all while lowering our risk. Next week we will discuss the building of a core portfolio.

Watch this segment of Top Dogs: Managing A Large Account with Tom Sosnoff and Tony Battista for an interesting introduction which drives home the benefits and necessity of using options.

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