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- Title
Benefits of Protecting Investment Portfolios with Options: A Historical Perspective.
- Authors
Dubil, Robert
- Abstract
• This paper examines the true effectiveness of options in protecting investment portfolios using 1967-2006 stock index data. Options theory typically ignores the bid-ask spread and has no room for volatility skew. We use real prices of S&P 500 options to account for both of these significant costs of using options. We compute terminal investment values, period returns, return-to-volatility (Sharpe) and return-to-semi-volatility (loss risk) statistics. • We overlayed an unprotected portfolio with five option strategies over 40-, 30-, 20-, and 10-year holding horizons, on a quarterly and yearly basis. We found several strong results that hold both for young investors (seeking return) as well as near-retirement investors (seeking low risk). • While most expensive, buying near- or at-the-money puts works best. Overall the return is similar to unprotected portfolios, but the risk is significantly reduced. Puts provide the highest reward-to-risk ratios. They should be used by investors who are retired or nearing retirement. • Put spreads (buy at-the-money puts and sell out-of-the-money puts) are cheaper than puts, but not effective. They result in lower returns and their risk mitigation is weak. A young investor seeking the highest possible return would be better off with a put strategy or no options. • Collars can, through the sale of high strike calls, reduce the cost of insurance, even to zero, and they help mitigate risk. But unless the strikes are well chosen, they can lead to a dramatic reduction of total return. • Using quarterly option strategies is better than an annual strategy, but if done right, both can work well in reducing risk and enhancing return.
- Publication
Journal of Financial Planning, 2008, Vol 21, Issue 2, p58
- ISSN
1040-3981
- Publication type
Academic Journal