SmoothSailing#37
There’s been all this focus on NVDA lately, then I came across this:
Which reminded me of one of the chapters in my book. Here’s an excerpt:
WHY WE SELL OPTIONS ON FUNDS NOT ON STOCKS
Back in 2015 there was a great study from Longboard called “The Capitalism Distribution”. They found that roughly 80% of the market’s entire gains came from 20% of all stocks from 1989-2015, while 80% of all stocks had a 0% gain. In other words, a small number of stocks made most of the gains. A growing body of evidence since 2015 supports that.
From that study:
“When most people think of the stock market they do so in terms of index results such as the S&P 500 or Russell 3000. They are unaware of the massive differences between successful stocks and failed stocks “under the hood” of their favorite index. 39% of stocks were unprofitable investments, 18.5% of stocks lost at least 75% of their value, 64% of stocks underperformed the Russell 3000. Only 25% of stocks were responsible for all of the market’s gains.”
And you think you can pick those stocks out of the rest? Good luck my friend. If you want to try it just keep in mind this should be the speculation part of your portfolio.
Selling options on a single stock seems more akin to betting on black at the roulette wheel. In fact you have better odds of picking the right spin of the roulette wheel than you do picking the next Tesla or Apple and actually holding onto it through the ups and downs and properly timing the entry/exit.
You can go down the road of value and growth stocks, technical or fundamental analysis, deep moat stocks, earnings momentum, capital structure, intrinsic value, “go with what you know,” dividend champions, etc., etc., in the search for just the right stock on which to sell options. But that list is endless and so is the time you’ll spend going down that rabbit hole. I prefer to have a life so I sell options on funds.
That said, there’s nothing wrong with being active in the market. Everyone, by definition, has to be some degree of active. You don’t need to settle for just piling all your money in a Vanguard Index fund and riding the waves. You also don’t want to speculate. Keep in mind the cardinal rule:
Successful stock picking is closer to voodoo than it is to science.
Cullen Roche, fund manager and author of “Pragmatic Capitalism” puts it this way:
“Owning individual stocks increases the overall risks of a portfolio. Numerous studies have shown that you need to own more than a hundred stocks to reduce diversifiable risk by 90 percent. In other words, to reduce company-specific risk sufficiently, you must own a large number of securities, dramatically increasing the time needed to manage such a large and complex portfolio. By the time you’re managing a portfolio that sufficiently neutralizes company-specific risk, you’re essentially holding a portfolio that closely resembles the market itself. What is the point?”
Once again I must reiterate, this is just my opinion. It’s also the opinion of the people I quoted here, and of just about every stock trading book I’ve read. But if y’all can make individual stocks work over a long period and you don’t get burned now and then, I’d love to hear what methodology you’re using; specifically how you pick ’em and how you decide when to sell ’em. If I’m wrong I’d love to hear about it.
Happy Trading!
