204  •   The Intelligent Option Investor
Portfolio Management
There is certainly no way around the tradeoff between OTM and ITM 
risk—the rules of leverage are immutable whether in a bullish or a bear -
ish investment—but there are some ways of framing the investment that 
will allow intelligent investors to feel more comfortable with making 
these types of bearish bets. First, I believe that losses associated with a 
bearish position are treated differently within our own minds than those 
associated with bullish positions. The reason for this might be the fact 
that if you decide to proactively invest in the market, you must buy se-
curities, but you need not sell shares short. The fact that you are losing 
when you are engaged in an act that you perceive as unnecessary just 
adds to a sense of regret and self-doubt that is necessarily part of the 
investing process.
In addition, investors seem to be able to accept underperform-
ing bullish investments in a portfolio context (e.g., “XYZ is losing, but 
it’s only 5 percent of my holdings, and the rest of my portfolio is up, so 
it’s okay”) but look at underperforming bearish investments as if they 
were the only investments they held (e.g., “I’m losing 5 percent on that 
damned short. Why did I ever short that stock in the first place?”). In gen-
eral, people have a hard time looking at investments in a portfolio con-
text (I will discuss this more when I talk about hedging in Chapter 11),  
but this problem seems to be orders of magnitude worse in the case of a 
bearish position.
My solution to this dilemma—perhaps not the best or most rational 
from a performance standpoint but most manageable to me from a psy-
chological one—is to buy OTM puts with much smaller position sizes than 
I might for bullish bets with the same conviction level. This means that I 
have smaller, more highly levered positions. The reason this works for me 
is that once I spend the premium on the put option, I consider the money 
gone—a sunk cost—and do not even bother to look at the mark-to-market 
value of the option after that unless there is a large drop in the stock price. 
Somehow this acknowledgment of a realized loss up front is easier to han-
dle psychologically than watching my ITM put position suffer unrealized 
losses of 1.5 times the rise of the stock every day.
This strategy may well be proof that I simply am not a natural-born 
short seller, and you are encouraged, now that you understand the issues