Credit Spreads vs Buy and Hold, a Comparison in Principle

BUY AND HOLD

The goals of buy and hold are long term appreciation and dividends taking advantage of the premise that stocks go up over the long run... blue chip large caps anyway. Perhaps some shorter term "investing" which is really longer term trading for some straight speculative gains plays.

Canadian and US registered accounts are a benefit in allowing these gains and dividends to grow tax free. Taxation only comes into play when the positions are sold and/or the resulting funds are removed from the registered account.

The idea that a long term holding does not have to be monitored and a that a drop in the portfolio will aways come back over time seems to be the mindset of most B&Hers...time frames not of the investors choosing though. Using stop loss orders or put buying, these positions can be protected. The issue becomes market timing to get back in at lower prices. Not many seem to be able to do this.

DRIPs alleviate some of the holding issues as dividends are re-invested in additional and partial shares. Over time this creates a compounding effect and the plan is to have the dividends produce an income stream sometime in the future. I find the time frame too long for my style.

The latest popular plan is to buy ETFs in place of stocks in order to provide some level of diversity. Some even promote buying index ETFs in order to gain the historical 11% per year of the general market. Fine if your time of capital needs lines up with the time of market strength. Sector rotation or sector relative strength are becoming know now as well. While decent strategies these are not strictly buy and hold plans as portfolios require re-balancing over time

CREDIT SPREADS

The goals of a credit spread strategy are income generation and risk aversion.

While not able to be executed in registered accounts the gains are realized monthly and taxed annually as income.

One major idea behind this style of plan is to take profits regularly thereby eliminating the chance of having a position drop below a predetermined loss allowance without having to set stop losses. Compounding is handled by increasing position sizing as profits accumulate to an additional contract size. Buying back into a position differs from stocks as each month a new set of options are available and buying back in is at the then price of the options given the strike prices chosen. Buy an option pair this month, letting it expire by month's end, turn it back into the next month's option pair at a similar price.

Selling high and buying low is, essentially, taken care of automatically.

Sector rotation or relative strength can be used to increase the already high probability of taking full profits from these trades with exposing the portfolio to undue risk. In fact, these additional strategy adjustments can allow a greater position sizing opportunity. Something that is not as easy to do with stocks unless using up margin.

COVERED CALLS?

Some would argue for a covered call strategy but it has it's downfall in that the underlying stock could drop substantially. While premiums collected by selling calls against the position can mitigate this problem it does not eliminate the issue altogether. It also requires more capital and risks having the stock called forcing the purchase of another position at a probably higher price.

While any strategy has it's benefits and drawbacks that must be taken into account I have found that credit spread trading fits my particular style and time requirements. I have run numbers to get a feel for what is needed to produce an annual money doubling strategy and they look very good and attainable while taking conservative risks and starting with small positions.

While I have gone on about various points and strategies in other posts I just felt a need to summarize to myself a few points drive the final nail in the coffin of buy and hold investing for me.

Jeff.