When first starting to invest many investors worry about margin being overused or underused particularly when trying to grow a small portfolio into a larger one. They also worry about not being diversified enough or having too few or too many stocks or holding too many in the same sectors. These are common and important questions to ask and they were posed to me from an investor regarding his use of available capital, margin and diversification as he starts a small portfolio with an eye to retire in 10 years. Let’s take a look at his question and then review some answers.

Investor Questions:

I have questions regarding margin and diversification.  Portfolio is 86K, and adding 6K/month. Currently have the following 3 positions (thanks to your suggestions):

INTC: Put ladders totaling 34K if I had to cover all assignments. Cost basis is 22.66 and breakeven is 18.4.

PCL: Put ladders as above totaling 24.8K if I had to cover all assignments. Cost basis is 41.33 and breakeven is 39.46.

VALE: Put ladders as above totaling 21.2K if I had to cover all assignments. Cost basis is 14.13 and breakeven is 11.32.

Currently have 86K in this portfolio, and the above positions total 80K if had to cover assignments on all. There is 72K of buying power for options remaining and 144K for stock. My trading plan includes rolling the above puts down if the market drops, rather than taking assignment. I understand this will mean additional capital during the roll down, to increase the number of sold puts.

Here are my questions:

  1. How is the capital usage for this small account? Overleveraged or underleveraged? Goals are to grow the account for retirement in 10 years. I want to use more of that option buying power to sell additional puts, but don’t want to over-leverage. Teddi keeps 30% of her portfolio in cash, which would mean only 60K in positions instead of 80K.
  2. Should it be more diversified? There are only 3 stocks, though tried to do extensive research and only go with the companies I wouldn’t mind owning. Dilemma is whether to continue only in these 3 so as to get the cost basis down on each one, for eventual ownership, or diversify for “safety”.

Sorry for the long email.  Any thoughts would be appreciated.

My Answers:

Let’s look at diversification first as it will assist in answering the first question later in the article.

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