Definition
Portfolio insurance techniques create a floor on portfolio losses. Protective puts provide direct hedging. Constant Proportion Portfolio Insurance (CPPI) dynamically shifts between risky and safe assets. Collar strategies combine protective puts with covered calls. The cost of protection (option premium, opportunity cost) must be weighed against the protection benefit.
lightbulb Example
A $1M equity portfolio buys S&P 500 puts 10% out-of-the-money for $25K (2.5% of portfolio). If markets drop 30%, portfolio loses ~$300K on stocks but gains ~$200K on puts, net loss = ~$100K plus the $25K put premium.
verified_user Key Points
- Protective puts provide direct downside hedging
- CPPI dynamically adjusts risky/safe mix
- Collars fund put protection by selling upside (calls)
- Protection cost ranges from 1-5% annually