Options for Beginners: How to Think About Diversification

Investing using options is very different from constructing a classic long-term buy-and-hold portfolio.

In this segment from Motley Fool Live that first aired June 7, Motley Fool Canada analyst Jim Gillies and Fool.com editor/analyst Ellen Bowman discuss why it’s not necessary to use options strategies on a wide variety of stocks to achieve success.

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Ellen Bowman: Let’s get to number 4, which is the enigma wrapped in a necessary diversification if necessary but not necessarily diversifications. Basically, this means that we’re going to approach options investing differently than we’re going to approach building on long-term buy-and-hold portfolio. For my long-term buy-and-hold, I’m going to want exposure all over the place, so I’m going to want to make sure that it’s got a different foundation necessarily that I’m going to need to worry about here.

Jim Gillies: In all seriousness, I think Jeff Fischer, for a couple of years, did one strategy on one company.

Bowman: He wrote puts.

Gillies: He wrote puts on Facebook (NASDAQ: FB) over and over. I think that’s all he did personally.

Bowman: Now, he’s an absolute genius investor, but I’m pretty sure that that was the foundation of his. I’m using the word foundation a lot. I guess we’re talking about foundational stuff. I remember something that he wrote for the service when he was still working on it was that people think that options are this really complicated thing. Actually, like you said, I did one strategy on one stock for years.

Gillies: But it was a stock that he knew well, so there’s our evaluation first, option strategy, second. Because he knew it so well, and yeah, he only did one strategy, but he could have varied it up. I look at diversification with options as I want to find a stock I know well first, so Jeff and Facebook. Find that, you know it well. Then the diversification comes not in the stock, it comes into strategies you deploy. If I know the company well and I think the stock is undervalued, I do a bullish strategy. I don’t set up a cover call which [inaudible] . If I think the stock is fairly valued, that’s when I do a neutral strategy, the cover calls with Britain puts, maybe a type of spread or two. If I think the stock gets a little overexcited and gets too heated, maybe I keep with the neutral strategies but maybe with a bearish slant on it. It’s the strategies that become diverse on the stock as the stock moves within your valuation corridor. But I know this stock well, and GameStop would be one of them in a previous life, as we’ve mentioned. But because I know it well, I can move around the diversification of the strategy rather than the stock. I don’t have to go learn another stock, although I do that for a living, but I can focus here. I can just focus on this thing. Spoiler, I’ve been running various options strategies on some company called eBay for about the last five or six years.

Bowman: What did they do?

Gillies: Some online auctions for Beanie Babies or something. But I know the company well. Actually, it’s been longer than that because my very first recommendation for Motley Fool Options, the month we launched in August of ’09, was a bull call spread on eBay.

Bowman: Was eBay?

Gillies: Was eBay. Today, I’m still running strategies on eBay.

Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Ellen Simonson Bowman has no position in any of the stocks mentioned. Jim Gillies has the following options: long January 2023 $45 calls on eBay, short January 2023 $45 puts on eBay, and short July 2021 $60 calls on eBay. The Motley Fool owns shares of and recommends Facebook. The Motley Fool recommends eBay and recommends the following options: short June 2021 $65 calls on eBay. The Motley Fool has a disclosure policy.

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