Can using derivatives be a good diversification tool or do they muddy the waters of an already diversified portfolio of 70% stocks and 30% bonds?
Covered calls - alternative to simply owning 100 shares of stock - for income or to slightly reduce risk
Sell Cash secured puts ITM, ATM, or OTM instead of owning the stock outright - to commit to purchasing the stock below the strike price and to give up any return above the strike price
Stock Replacement - deep ITM calls - buying 1 call option instead of owning 100 shares in stock. Use a CD or short-term bond for the difference. The major downside is to not receive dividends
Call / Put Spreads - to sell an upside call / buy a downside call or buy an upside put / sell a downside put or the reverse
Collars on Stock positions - selling a call and buying a put against 100 shares of stock to limit both your upside and downside
Are these poor strategies or are they legitimate alternatives to market timing to reduce risk while not giving up all the return that going to cash would cause?
These are risky for the Amateur. Much more risk than you should take.
If you decide to proceed, I suggest you put no more than 10% aside and call it gambling/play around money and see how it goes.
How much time do you want to commit to this. It is not a buy and forget type of investment like an index fund.
Regardless of the intent, derivatives are by nature, a couple of iterations removed from their source of value. In addition, real or contrived value gained from their being a derivative of another thing which might or might not have real value just makes them more opaque. When selecting a thing to invest in, I suggest that transparency of the basis of that investment is good and opaqueness is bad.
Opaqueness of derivatives was a major, if not THE major factor behind our last global financial crisis.
Covered Calls are not “an alternative to simply owning 100 shares of stock”. You already own the stock and you are selling Call options to hedge downside risk and collect premium. I’ve tried this strategy with varying degrees of success. Ive been more successful using it when owning dividend-paying stock and selling OTM LEAPS along the way.
I agree. Since you’re collecting premium, you lower risk and thus should expect a lower return as you’re giving up the upside similar to a put sale
I feel like options have been a way to invest in an asset class or to hedge against a cash position - buying a call option on the S&P for instance
Maybe I want to collect premium in exchange for committing to buy 100 shares of stock. Like a covered call, I do give up the upside above the strike price. The difference is when you get assigned
I like this.
Current positions are
1 Call 41 EFA about $1,800 - EFA $5,712
1 call 35 EMXC about $1,100 - EMXC - $4,532
$6,700 401k loan in which options are hedged
Covered calls are terrible. You are owning a stock hoping it will go up. With covered calls if it goes up then you lose the stock.
Options have a lot of moving parts there’s the stock price and then time decay, the bid and ask spread etc.
Yes if you own 100 shares of stock then you sell a covered call in the attempt to collect that time decay. In contrast buying a call is hoping to collect volatility. Buying a put hopes to profit from or insure against a decline. And selling a put is intending to purchase 100 shares of stock if the stock falls below the strike price. Covered calls are terrible; you give up all the upside as your goal is to profit from time decay
So the goal of selling options (naked or covered) is to profit from high volatility. When the VIX is running up you will see premiums increase and that is the time to sell premium. When the VIX is running way down premiums will decrease and that is the time to buy premium. During the recent decline I was selling naked puts on many dividend stocks that I would like to purchase more shares.