Lowering my risk profile (AA or options)

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dandan14
Posts: 963
Joined: Wed Feb 11, 2009 7:32 am

Lowering my risk profile (AA or options)

Post by dandan14 »

Typically, I have been slowing shifting my AA more toward bonds as I've gotten older and closer to "winning the game."
As I've grown increasingly uncomfortable with the idea of loss, I'm thinking of making a more significant shift to my strategy.

I'm currently 75/25.
I believe I have 3 options with similar risk/reward profiles. 2 of them would use long term options (i.e. LEAPs), likely of a 1 year duration to keep it simple.

1. Shift AA to something like 60/40 or 50/50. This is a straight line payout. Softens, but does not cap, downside. Lessens upside.

2. Keep my AA at 75/25. Buy some protective puts on the index to limit my downside. This is the shape of a hockey stick -- with the downside significantly softened by having the payout of the options and paralleling the original portfolio on the upside (less the premium). You give up 1-2% on the upside for the price of the options, but not nearly as much upside as you would give up by shifting to a lower AA.

3. Shift AA to more conservative and buy calls on the index. Buy some calls to offer a little upside potential. This softens downside, but doesn't cap it. Small/moderate gains in the index would be significantly impacted by the price of the call. Significant gains in the index would make the option payout and give the portfolio some upside.

What are your thoughts?
Any books that explore this in detail?
Anyone using strategies #2 or #3?
alex_686
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Joined: Mon Feb 09, 2015 2:39 pm

Re: Lowering my risk profile (AA or options)

Post by alex_686 »

Historically there is not much differfence in thhe 3 strategies. Writing calls does deliver higher returns over the past 40 years or so. The problem here is tail events - big sudden down movements. So it is hard to tell if the risk adjusted return will actually be better. I would go with option #1. Simpler.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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dandan14
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Joined: Wed Feb 11, 2009 7:32 am

Re: Lowering my risk profile (AA or options)

Post by dandan14 »

I've been running scenarios all weekend.
I'm leaning toward calls. I can shift my overall AA to 50/50 which will help me sleep better at night. Then I'll buy some 1 year calls every January for a cost of about 1% of my portfolio. (I've run some calcs, and I can make most of the shifts inside of IRAs to avoid capital gains.)
For that 1%, I get the downside performance of 50/50 and the upside performance of 75/25.
I feel pretty ok with that.
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