I’m often asked why I use IWM almost exclusively for options selling. The book has an entire chapter on that subject, but I’d like to add a bit more here. This week I compared some AMZN puts at varying dates to identical IWM puts, using the same delta to keep things equal. The premiums paid were very close to the same, and in a couple of examples, IWM even paid more than AMZN. So why take the risk of owning a single stock to generate premium when IWM can do the job?
In addition, I recently read Cullen Roche’s book, “Pragmatic Capitalism”, and came across this quote, which reinforces the idea that owning individual stocks is riskier than I want to accept.
“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?”
Then I came across this. Before his death in 1976, famous value investor Benjamin Graham said:
“In general, no, I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40, years ago, but the situation has changed a great deal since.”
So if we can’t consistently use technical or fundamental analysis, and individual stocks just add risk to a portfolio, then yeah. I’m sticking with IWM.