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Theory Versus Practice

The concept of using options in your long-term portfolio works as long as you structure that use within the guidelines of your conservative risk profile and consider all possible outcomes. For example, whenever you go short on either calls or puts, you should fully understand the consequences of exercise.

The primary requirement for a conservative application of options is that any and all strategies should involve stock that you have qualified under your individual standards, that you either own or want to own, and that you consider an attractive long-term investment. Nonconservative option strategies tend to be overly complex and, while they may work out quite well on paper, they do not always produce the high rates of return that seem so easy. Stocks rarely move in the desired direction, or quickly enough, for high-risk strategies to become profitable. Speculators—especially inexperienced ones—often pay too much attention to the profit potential of complex option combinations and far too little to the associated high risks. In especially complex option strategies, the minimal loss is often offset by a related minimal profit as well. In calculating the cost of opening these positions, speculators often suffer a net loss due to trading expenses for opening and closing the positions.


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