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Chapter 9. Stock Selection and the Optio... > Temptation to Select Most Volatile S...

Temptation to Select Most Volatile Stocks

When your conservative portfolio does not perform as you expect, what can you do? Some investors are tempted to sell lackluster stocks and go with more exciting, more volatile issues. The idea is that you can experience profits more rapidly, make up for past losses, and outperform the market. In fact, though, this approach is an abandonment of conservative principles. You need to continue to carefully select value stocks and then protect their equity value. That is the true conservative strategy.

Investors who like the idea of using options also face danger if and when they pick stocks inappropriate for the conservative risk profile. If you shop option premiums with the idea of buying stock and then discounting your purchase price with covered call writes, you are taking the wrong approach. A conservative application of options requires that you first select stocks based on fundamental analysis and comparison; that you pick stocks with lower-than-average volatility and the potential for price appreciation; and that the capital structure, revenue and earnings, PE ratio, dividend history, and other indicators of your stocks are a good fit for your conservative standards. Then, you use the various conservative option strategies to protect equity and enhance current income. Remember, using conservative option strategies on risky, volatile stocks contradicts your standards. The first rule is, pick your stocks carefully and then identify methods for protecting their value.


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