Final answer:
A portfolio manager using index options is trying to reduce systematic risk, which affects the entire market. Index options act as a hedging tool against market downturns, complementing strategies like diversification. Diversification is key to reducing unsystematic risk, while index funds provide an easy way to achieve this.
Step-by-step explanation:
A portfolio manager using index options is typically trying to reduce systematic risk, which is the risk inherent to the entire market or market segment. Systematic risk, also known as market risk, affects the overall market and is not specific to a particular stock or industry. By using index options, portfolio managers can hedge against potential downturns in the market as a whole, thus protecting the portfolio against fluctuations that affect broad segments of the financial market.
Diversification is an important consideration for investors because it can help reduce unsystematic risk, which is specific to a company or industry. However, diversification does not protect against systematic risk; that's where financial instruments like index options come into play. An index fund, for example, provides automatic diversification by tracking a market index and including a wide range of securities, thus helping to mitigate unsystematic risk.
Buying a house to live in can also be seen as a type of financial investment because it has the potential for capital appreciation over time and can provide leverage benefits. However, it does not provide the same kind of diversification benefits as investing in a broad range of financial assets like stocks or bonds.