Specialization, Diversification, Yield and Perspective

For anyone reading, keep in mind that the purpose of this blog is more for my own "thinking out loud" so some of what I write is repetitive or obvious or just dribble. This may ramble about as I mush out some thoughts and direction.

I updated my sector performance chart.

Comparing it to the Dec 11th one

The same sectors are under performing and over performing against the S&P500, but this is only 5 trading days later.

I am finding that this is giving a good relative performance indication and I could likely run trades based on this, buy the over performers and short or buy inverse ETFs on the under performers in line with the overall market trend. The trouble is trying to use this for spreads on the ETFs. There is not much to capture in the difference in option premium vs the spread size or risk. I mentioned just plunking my cash into Optioneer as they are able to see trades that average in the 8-10% Return On Risk whereas I am starting to see perhaps 4-5% ROR. I thought that perhaps it had to do with Optioneer using iron condors, taking both the call and put side simultaneously but I determined that doing so would only serve to reduce the ROR as call and put premiums vary depending upon the price point of entry (top of the trend channel is best for calls and bottom for puts). Legging would be best but still yields are small.

Of course there are the largest considerations:

Specialization
Diversification
Yield
Perspective

I actually went looking for dividend stocks today out of curiosity, I wanted to get something to stick in the TFSA to be left to grow until I remembered that yields are in the 5-10% for good dividends...per year. Here I am worrying about losing a few percentage points per MONTH.

That looks after the perspective issue for me.

Specialization is easy enough to consider as being able to trade one stock profitably is a good thing, if it can be done relatively consistently.

Diversification is easy as well. trading one stock sounds like putting everything in one basket until I consider that trading the SPY which is tried to the S&P500...500 stocks altogether. It doesn't get much more diversified than that, which provides another interesting problem.

Yield, well, the yield will be the yield and will beat all dividend producers even over the long haul if I just manage to double them, let alone possibly stepping up returns by an entire order of magnitude.

OK, so trading one ETF is diversity but if it is SPY then it can be OVER DIVERSIFIED...huh?

Sure. Trading one over or under-performing sector allows diversity when using ETFs but allows exceptional performance due to specialization. This is the key why SPY can return a better yield in spread trading than most sector ETFs...because it is over-diversified as it represents ALL sectors it cannot help but perform in a rather mediocre style. Just look at the above charts and see that the SPX is consistently ranked 5, 6 or 7 in all categories.

This is the hallmark of a great vehicle to trade a method that works best with relatively non-volatile securities. This allows wider margins and tighter spreads to both give a lesser risk profile over all while still providing a decent yield. Finding the right security to match a preferred method of trading is like curve fitting... but even that has it's advantages.

Next up... diversity through S&P500 price levels.

Jeff.