Options and Modern Portfolio Theory

It’s not surprising. It used to be all the talk amongst the financial egghead group. But now, the dawdling masses are catching on. Not many stock or option investors know about the investment theory that won a Nobel Prize in 1991. Nor do they know about a landmark study that showed that over 90% of the returns on an investment portfolio comes from how- not what- you own in your portfolio.

That’s right. Not the hot picks, top rated or whatever system stock picker gurus use. While most “lay” stock and option investors watch the flash- bang of Wall Street marketing, the buttoned down mathematicians and portfolio managers quietly put the new theory to use. There’s probably a good reason why most investors don’t know about this remarkable study and the importance of Modern Portfolio Theory (MPT). You see, there is a huge industry dedicated to telling you how to invest and what to buy.

MPT is a major tool for professional investment managers and this fact might also be another factor that keeps it mostly invisible to the average retail customer. Up until recently, the the big bang theory sophisticated Nobel Prize winning strategy needed somebody with an MBA or PHD to implement the strategy. But now the tools needed are accessible and easy to use for almost any non-egghead stock or options investor.

Modern Portfolio Theory for Newbies

In a nut shell, MPT says that to minimize investment risk and optimize portfolio returns, close attention needs to be paid to the proper balance of¬†asset classes¬†within a portfolio. This is not to be confused with asset diversification. Asset class means types of investments with varying correlations. For example, you don’t want too many investments that move together in sync. That’s O.K when the market is going up and positions are long. But if things turn dicey, closely correlated investments all go down together; eggs in the same basket sort of thing. Investment asset diversification only pretends to give that sort of protection. Having different asset classes with varying correlations in a portfolio does. The important thing is that varying correlation promotes lower overall risk which helps allows an investor to add some kick to the portfolio and boost total returns.

More kick in your portfolio

Listen to this: a study done by the Chicago Mercantile Exchange demonstrated that a portfolio with as much as 20% of investment assets in futures and options yielded up to 50% more than a portfolio limited to low and moderate risk investments.

Leave a Reply

Your email address will not be published. Required fields are marked *