2019•Unpublished venueRequires access
Portfolio Insurance
Keith Cuthbertson, Dirk Nitzsche, Niall O'Sullivan
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Abstract
This chapter shows how static stock+put insurance can achieve a lower bound for the value of a diversified stock portfolio, while maintaining most of the upside potential. It analyses how day-to-day price changes of a ‘stock+put’ portfolio can be replicated using either a ‘stock+futures’ portfolio or a ‘stock+T-Bill’ portfolio. Replication portfolios are used because they are often less costly than directly using the ‘stock+put’ combination. Portfolio insurance is a general term which refers to a strategy of hedging an equity portfolio to ensure that it does not fall below some prescribed minimum value, while also retaining most of the upside potential, should stock prices increase. Prior to the 1987 stock market crash, dynamic portfolio insurance was very popular as transactions costs are lower for rebalancing a ‘stock+futures’ portfolio, than for the actual stock+put position.