There’s probably a good reason why most investors don’t know about the rather 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. Moreover, 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 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.
Modern Portfolio Theory for dummies
In a nut shell, MPT says that to minimize 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 assets that move in sync. That’s O.K when the market is going up and positions are long. But if things turn dicey, they all go down; eggs in the same basket sort of thing. Asset diversification doesn’t give that protection. Having different asset classes in a portfolio does. The important thing is that varying correlation promotes lower overall risk which then allows an investor to add some kick to the investing portfolio; higher reward-risk investments.
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 assets in futures and options yielded up to 50% more than a portfolio limited to low and moderate risk investments.
Stock Options are perfect for the 10-20% of a portfolio balanced for risk reduction. Options offer high leverage so the 10-20% of a portfolio can represent a much larger percentage of assets held. For example, if you have a portfolio with $200,000 in assets, if 10% of the portfolio is in options, the $20,000 alone could provide up to an additional $200,000 or more in rights to assets on top of the value of the balance of the portfolio. In this case, the total portfolio would be invested in $180,000 (90% of the portfolio) and $200,000 of leveraged options for a total of $380,000 from which to obtain returns.
Used together with Modern Portfolio Theory, using the flexibility and leverage of options makes for a potent strategy. Consider the important fact that even a slight increase in portfolio returns can make a big difference over time. Indeed, more investors should take a look at ways to optimize return and reduce risk. MPT and options is a strategy worth investigating.
To learn more about currency trades see here
