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Strategies & Market Trends : The Covered Calls for Dummies Thread -- Ignore unavailable to you. Want to Upgrade?

To: Wyätt Gwyön who wrote (2143)	8/20/2001 2:40:44 PM
From: Dan Duchardt	Read Replies (2) \| Respond to of 5205

Mucho, it may or may not be worth debating what is or is not obvious, but i think there is indeed something counterintuitive in the idea of mixing SDs of different covariances and thereby achieving a lower SD for the targeted return. for example I'm not debating what is or is not intuitive or obvious. I was just pointing out that all of us who look at the behavior of an index or some other basket of stocks have witnessed the phenomenon that it tends to be "more stable" than a subset of that basket. And going beyond that to the logical conclusion that if you buy the basket you achieve greater stability at the expense of any opportunity to skew your returns to the plus side. i think you are really bringing up a different line of argument here. first you are talking about the SD of the entire universe of assets being smaller than that of its component classes, then you talk about trying to invest with minimum SD from the S&P. the first SD is not the same as the second. I don't think I said, or implied that the SD of the S&P was the same as SD of the universe of all possible assets. I was using the S&P as an example of a universe familiar to most of the readers here to illustrate that asset classes within the universe exhibit the kind of behavior you are talking about in relation to that universe. It is not a different argument, it is just a different universe. Every problem of this sort has to be worked within some sort of boundary defining the universe you are looking at. The S&P is certainly one possible asset class within a much larger universe, and likely has a larger standard deviation than that broader universe. the idea of asset class mixing to achieve an efficient frontier is very different from the idea of simply "beating the S&P" by selecting the better performers within the S&P. the resulting portfolio is unlikely to be efficient, because the S&Pconsists primarily of US large caps and is skewed heavily toward growth I have not read what you have read, and I will concede there might be something to it that I am not grasping. If it is what seems right for you, then by all means do everything you can to achieve that efficient frontier. I am not arguing that anything you are saying is wrong. By the definition you have given, a broad asset allocation will be more "efficient". I agree with that, but I'm not at all convinced that the efficient frontier is always the place I want to be. I certainly don't want to be there when the universe is absorbing my money. Perhaps we need a more precise definition of what this SD is that appears in those graphs you talk about. For me, a small SD conjures up the idea of a linear progression (or perhaps linear in the log; growth at a constant percentage) from the starting point to the end point. In other words, the SD that comes from a linear regression calculation (or what I think is the common definition, the standard deviation of the rate or return from one day to the next). "Efficiency" then means that any excursion from this linear trend is small. That's a nice place to be if you are a buy and holder, content to take whatever gain evolves over some period of time with no concern about deviations one way or the other from this line. But that is NOT what a lot of people want. The people around here who are trying to generate income from writing calls do not want stocks that have no volatility, because they could not collect premiums and buy back calls on dips to pocket some money. It is a different mentality. Also, when talking about volatility or standard deviations you have to do it in the context of a time frame. I believe you said the graphs you see in the reference you site are based a 5 year time frame. The period since March 2000 has drastically boosted the volatility of the Nasdaq. But there were periods of time during the great Nasdaq bubble when the SD was considerable lower. There was also a long period from September 2000 to April 2001 where the volatility was not all that great compared to the 5 year volatility, but unless you were short you wanted no part of that "efficiency". I'm not judging who is right or wrong, because that may be different for different people. An asset class that is wandering all over the place but going nowhere fast may be highly "inefficient" and undesirable to you, but if those excursions are in any way predictable (meaning they have small SD calculated over a much shorter time frame) they are a trader's dream. Dan