414 Part IV: Additional Considerations 
mitments to option purchases so that his overall risk in a one-year period can be kept 
down to nearly 10%. 
Example: An investor might decide to put 2½% of his money into three-month 
option purchases. Thus, in any one year, he would be 1isking 10%. At the same time 
he would be earning perhaps 6% from the overall interest generated on the fixed­
income securities that make up the remaining 90% of his assets. This would keep his 
overall risk down to approximately 4.6% per year. 
There are better ways to monitor this risk, and they are described shortly. The 
potential profits from this strategy are limited only by time. Since one is owning 
options - say call options - he could profit handsomely from a large upward move in 
the stock market. As with any strategy in which one has limited risk and the poten­
tial of large profits, a small number of large profits could offset a large number of 
small losses. In actual practice, of course, his profits will never be overwhelming, 
since only approximately 10% of the money is committed to option purchases. 
In total, this strategy has greatly reduced 1isk with the potential of making 
above-average profits. Since the 10% of the money that is invested in options gives 
great leverage, it might be possible for that portion to double or triple in a short time 
under favorable market conditions. This strategy is something like owning a convert­
ible bond. A convertible bond, since it is convertible into the common stock, moves 
up and down in price with the price of the underlying stock. However, if the stock 
should fall a great deal, the bond will not follow it all the way down, because eventu­
ally its yield will provide a "floor" for the price. 
A strategy that is not used very often is called the "synthetic convertible bond." 
One buys a debenture and a call option on the same stock. If the stock rises in price, 
the call does too, and so the combination of the debenture and the call acts much like 
a convertible bond would to the upside. If, on the other hand, the stock falls, the call 
will expire worthless; but the investor will retain most of his investment, because he 
will still have the debenture plus any interest that the bond has paid. 
The strategy of placing 90% of one's money into risk-free, interest-bearing cer­
tificates and buying options with the remainder is superior to the convertible bond 
or the "synthetic convertible bond," since there is no risk of price fluctuation in the 
largest portion of the investment. 
The Treasury bill/option strategy is fairly easy to operate, although one does 
have to do some work every time new options are purchased. Also, periodic adjust­
ments need to be made to keep the level of risk approximately the same at all times. 
As for which options to buy, the reader may recall that specifications were outlined 
in Chapters 3 and 16 on how to select the best option purchases. These criteria can 
be summarized briefly as follows: