If you’re trying to note the presence of a negative volatility risk premium paid by option buyers, you are correct (and with such nice dramatic flourishes!). Academics have noted and analyzed the phenomenon extensively, and many traders exploit it in practice.

That phenomenon does not exclude the fact that it is rational for many investors to pay the vol premium to reduce the risk in their portfolios over a relevant time frame. The vol risk premium is not prohibitively large, it keeps getting smaller, and prior to the financial crisis there were discussions in some circles about whether it would continue to persist at all. For the practical purposes of average investors with their own goals and time horizons, your concerns are misplaced.

The “second order” risks you allude to are obviously not relevant in the case of a risk-defined hedged stock position. Nobody is advocating being naked short convexity here; quite the opposite.

If you don’t want risk in your portfolio, buy sovereign bonds. If you want risk, buy a well diversified portfolio of the right sort of equities.

This claim is false. A stock position and a collared stock position have strikingly different risk/reward profiles. And the risks of each position are perfectly clear.

Your anecdotes regarding market structure prove too much: if the standard for whether someone should trade a given product is whether liquidity providers make any profit, then no one should ever invest in options, stocks, bonds, or chickens.

I understand how markets work very well. Some years ago, I spent time as an external consultant at a bank (which shall remain nameless), building pricing models for their central risk managment, and I got to see their retail options business – one of the striking things about this (which was selling, essentially, packaged collars and similar) was how casual people were – note, not particularly predatory, more with a shrug of the shoulders – about how this was a business of taking money off little old ladies. It was a memorable learning experience.

http://www.theivyportfolio.com/

I never suggested that anyone buy options as a plan to earn a profit. Option buying for gain is a very difficult task.

And if that person who sells the option is a genius and does know more than you, so what? Your purpose is to protect your assets from destruction. How is the fact that someone may know more than you suggest that your trade is not ideal for your personal situation or that the price is anything but fair? That seller is not the only person selling those options at the same price.

You completely misunderstand the markets. The seller of any option or stock ALWAYS thinks there is something to gain in the trade. And the buyer feels exactly the same. With stocks, someone is right and someone is wrong. But, with options, both parties can gain from the transaction, when one of the parties is reducing risk by hedging a position.

The collar strategy requires the sale of call options and the purchase of put options. This is a worthwhile strategy for the conservative investor.

For many Americans up to the eyeballs in high interest debt, a fairly good bet is to pay that down.

Infrastructure may be a decent bet in the coming years. It is tangible and is therefore an inflation hedge. Plus, it is likely that state and local governments under financial duress in the coming years will want to unload assets.

Jim Rogers sees farmland as the best play right now. Again, it’s tangible, hence an inflation hedge. It will continue to be as important as it has been since the dawn of man. Need to find a way to rent that and get decent yield in the interim, if you aren’t a farmer yourself. If you are a farmer, he tells you Maseratis are in your destiny.

This will not protect you from catastrophe, but it is more likely to do so than any other strategy.

Stock options are designed to reduce risk. If anyone believe owning TIPS is a good long-term investment, well so be it.

But for anyone who wants to own stock market investments with at least a portion of his/her portfolio, then understanding basic option strategies can only help.

Options reduce risk. It’s that simple. I recommend the collar strategy, and Jared recommends half of that strategy. The collar limits profits, but in return, the puts cost little or nothing.

Be informed. Learn how options work. The make an intelligent choice.

Here’s a basic explanation of the collar strategy with an example: http://tinyurl.com/lwxo4x