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Preface

Preface

The Elusive Goal: Low Risk and High Yield

Is it truly possible to match low risk with high yield? Most experts question the idea that there are ways for risk-averse investors to outperform the averages. However, conservative investors can exploit a narrow band of potential strategies to dramatically increase yields and, at the same time, manage risks within their self-defined risk limitations.

To some conservative investors, options are too exotic and too risky. If a range of strategies is too much trouble or contains too many pitfalls, it is not worth pursuing. But we proceed on the premise that a conservative investor is not necessarily someone who does not want to expand beyond a well-understood and short list of investment possibilities. Being a conservative investor does not necessarily mean that you are unwilling to examine new ideas, expand your portfolio, or take acceptable risks. It means that you are not interested in speculation or in exposing yourself to the possibilities of high risk.

Investors tend to be aware of the potential for high returns without also acknowledging that such strategies are usually accompanied by unavoidable high risks. This is where the inexperienced suffer losses in the market. The lack of experience that attracts the novice to speculation in options and other high-risk strategies has caused much grief in the market. When we look back at the dotcom years, we see that many first-time investors made quick paper profits, only to lose it all in a sudden reversal of fortunes. But conservative investors know that putting all of their capital in a single industry is ill advised, especially if they select companies that have never reported a net profit or whose stock has risen over $200 per share in a few months or whose actual core business is only vaguely defined.

Given these observations, conservative investors naturally seek methods for using their capital that achieve some very specific goals, including the following:

  1. Preserving spending power after both inflation and taxes.

  2. Avoiding unacceptable market, liquidity, and diversification risks.

  3. Protecting profits without loss of invested positions.

These goals are typical for conservative investors and actually would serve moderate investors just as well. They all involve methods of avoiding loss. As a conservative investor, you are not averse to risk in any and every form; essentially, you are averse to unexpected surprises. This is perhaps the most important distinguishing characteristic between you and other investors. The majority of novice investors are surprised when they lose money in the market but, in retrospect, should they have been surprised? In most situations, the novice was operating on certain assumptions concerning potential profits, but was unaware of the related risk or the degree of risk exposure. Otherwise, his or her investment decisions probably would have been different.

With this in mind, we offer a more realistic definition of the conservative investor: one who is experienced enough to be aware of both yield and risk, and who makes decisions based on that broad awareness. Conservative investors are not as likely as other investors to be taken by surprise when they lose money in the market. Another aspect of this expanded definition distinguishes between risk profile and the willingness to use creative and alternative strategies. The conservative is not close-minded and does not reject exotic instruments like options merely because of their reputation as high-risk. Instead, the well-informed conservative is likely to examine claims about high-yield potential with an open mind. You may be skeptical and, at the same time, willing to listen to the suggestion that the combination is at least possible. A limited number of strategies do, in fact, offer the potential for various conservative applications to meet the three goals common to conservative investors: preserving capital, avoiding unacceptable risk, and protecting paper profits. We have summarized 12 strategies in this book (see the appendix) and qualified them in terms of risk levels.

This book does not suggest that you have to become an expert in a broad range of complex or exotic options strategies. Instead, it proposes a rather limited number of strategies appropriate for conservative investors. Our purpose is to respect the risk limitations in the conservative strategy while showing how experienced stock market investors can expand their yield levels significantly, protect existing positions, and come through down cycles in the market intact.

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