Option to reshape P&L smooth, allowing sizable position to produce profit
Nature of option is to precisely value and control risk. For many strategies, smartly using option structures can reshape your P&L (profit and loss) to be smooth, meaning 1) max loss is limited, 2) no steep loss.
Of course the P&L reshaping has a cost. But this is the key to real profit: a smooth P&L with limited max loss enables you to apply sizable position to produce good profits.
Reason is simple: without limited risk, rational investor will not place a big position, otherwise the account could suffer huge loss if holding long enough. Therefore, many good strategies can only work as "toy strategies".
This also explains the consistency between profit & efficient market theory: your profits are not from mis-priced assets, rather, it's from larger but safer positions.
Actually many successful investors are using this rule (they reshape PL to be smooth but not limited to using options):
* Bridgewater: textbook example of using uncorrelated assets to make smooth PL, then apply leverage. They don't use options because their fund is too large.
* Soros: his book Finance Alchemy recorded his usual portfolio structures: long/short stocks, long/short FXs, long/short interest products, long/short commodities -- overall it produces a smooth P&L allowing him to apply 3x leverage of his fund's capital.
* Cliff Asness (AQR fund): very similar to Bridgewater.
* Buffet: not a typical example but very similar: he finds and holds long-term stable & increasing stocks that are not perfectly smooth but drawdowns are quite limited, then he applied leverage with Insurance Float.
