Pathetic Protection: The Elusive Benefits of Protective Puts
41 Pages Posted: 23 Mar 2017
Date Written: March 17, 2017
Conventional wisdom is that put options are effective drawdown protection tools. Unfortunately, in the typical use case, put options are quite ineffective at reducing drawdowns versus the simple alternative of statically reducing exposure to the underlying asset. This paper investigates drawdown characteristics of protected portfolios via simulation and a study of the CBOE S&P 500 5% Put Protection Index. Unless your option purchases and their maturities are timed just right around equity drawdowns, they may offer little downside protection. In fact, they could make things worse by increasing rather than decreasing drawdowns and volatility per unit of expected return.
Keywords: Option, Options, Put Option, Protective Put, Put Protection, Protection, Portfolio Protection, Volatility Risk Premium, Variance Risk Premium, Insurance, Insurance Risk Premium, Tail Risk, Tail Protection, Crash Risk
JEL Classification: G00, G10, G11, G12, G13
Suggested Citation: Suggested Citation