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Chapter 3. Options in Context > Perceptions About Options

Perceptions About Options

Not only do options have a place in your conservative strategy; properly employed, options can strengthen your portfolio and provide greater protection than well-selected stocks. Because prices tend to move in cycles, short-term and intermediate-term pricing may be erratic, and even the best-chosen stocks go through reversal and consolidation patterns.

One argument concerning long-term planning is that such changes in price are of no concern. As long as long-term fundamental signals continue to show strength, the conservative philosophy is to hold, accumulate, and wait out the market. This traditional approach observes correctly that short-term pricing is unpredictable as an indicator, a belief held by followers of both the Dow theory and the random-walk hypothesis. Short-term price movement is not useful for any sort of long-term predictive use. However, it remains possible to (a) protect paper profits and even take those profits without selling shares, (b) exploit market price overreactions, and (c) generate current returns—all without taking on added market risks. As previously noted, the lost opportunity risk associated with committing shares of stock to a fixed strike price should be evaluated along with the rates of return, the value of downside protection, and the yield diversification we achieve with the use of options in a conservative manner.


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