Risk aversion is a common trait among investors. While it is possible to reduce risk attributed to specific industries and regions by diversifying among different securities, market risk affects all securities on the market. Even a perfectly diversified portfolio is subject to systematic or market risk. It can be managed through diversification across asset classes, for example by shifting some of the funds invested into risk-free assets. For some investors, this yields unsatisfactory results as the expected return directly decreases linearly with an increase in the position in the risk-free asset. Portfolio insurance (PI) describes an alternative set of strategies that allows investors to reduce their exposure to market risk by guaranteeing the value of the portfolio to be above a certain value at the end of the investment period while allowing for participation in rising stock markets.
Option-based portfolio insurance (OBPI) refers to a set of strategies in which either a conventional put option (protective put) or a replicated put option (synthetic put) is used to insure a portfolio against adverse price movements. In theory and assuming perfect market conditions, protective put (PP) and synthetic put (SP) yield identical payoffs and have the same cost. In practice, there are several important differences between the two strategies. On the one hand, PP seems to be an easy and uncomplicated strategy to implement, but the unavailability of listed options with desired maturities and strike prices are major issues. SP strategies, on the other hand, can suffer from obstacles like high transaction costs and jumps in stock prices.
Inhaltsverzeichnis (Table of Contents)
- Introduction
- Overview of Portfolio Insurance
- Origins
- Using Portfolio Insurance to Manage Exposure to Market Risk
- Theoretical Framework for Protective and Synthetic Put
- Option Pricing
- Protective Put
- Synthetic Put
- Evaluation of Option-Based Portfolio Insurance
- Refinements and Considerations
- Advantages and Disadvantages of Protective Put and Synthetic Put
Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)
This thesis analyzes the efficiency and performance of option-based portfolio insurance (OBPI), focusing on protective put (PP) and synthetic put (SP) strategies. It examines the theoretical framework, practical considerations, and comparative advantages and disadvantages of these strategies within the context of managing market risk.
- Option pricing theory and its application to portfolio insurance
- Practical implementation of protective put and synthetic put strategies
- Comparative analysis of protective put and synthetic put strategies
- Risk management and market risk reduction through portfolio insurance
- Evaluation of the effectiveness and efficiency of OBPI strategies
Zusammenfassung der Kapitel (Chapter Summaries)
Introduction: This chapter introduces the concept of portfolio insurance (PI) as a risk management strategy for mitigating market risk. It highlights the limitations of traditional diversification and introduces option-based portfolio insurance (OBPI) as an alternative, employing either protective puts (PP) or synthetic puts (SP) to guarantee a minimum portfolio value at the end of the investment period. The chapter outlines the thesis's objective of analyzing the efficiency and practical aspects of OBPI, emphasizing the differences between PP and SP strategies and the importance of considering practical refinements when implementing these strategies.
Overview of Portfolio Insurance: This chapter delves into the origins of portfolio insurance, tracing its development from Leland's initial concept in the 1970s. It explains how a protective put (PP) strategy guarantees a minimum portfolio value by using a put option, contrasting this with the synthetic put (SP) strategy, which replicates the put option payoff using a dynamic portfolio of assets. The chapter underscores the theoretical underpinnings of PI in option pricing theory, emphasizing the contributions of Black, Scholes, and Merton. It also touches upon the practical implementation of PI, particularly the role of LOR Associates in popularizing this strategy.
Theoretical Framework for Protective and Synthetic Put: This chapter provides a detailed theoretical analysis of protective put (PP) and synthetic put (SP) strategies. It explains the option pricing theory relevant to OBPI, focusing on the Black-Scholes-Merton model. The chapter offers a thorough description of both PP and SP strategies, highlighting their similarities (identical payoffs under perfect market conditions) and differences (practical implementation challenges like transaction costs and market imperfections). This lays the groundwork for a detailed comparison in subsequent chapters.
Evaluation of Option-Based Portfolio Insurance: This chapter presents a critical evaluation of OBPI strategies. It addresses practical refinements and considerations for implementing OBPI in real-world markets, moving beyond the idealized theoretical framework. The chapter then conducts a comparative analysis of PP and SP strategies, weighing their respective advantages and disadvantages. This includes a discussion of potential obstacles such as transaction costs and the limitations of available options, supported by a Monte Carlo simulation.
Schlüsselwörter (Keywords)
Portfolio Insurance, Option-Based Portfolio Insurance (OBPI), Protective Put (PP), Synthetic Put (SP), Option Pricing, Black-Scholes-Merton Model, Risk Management, Market Risk, Hedging, Investment Strategies, Monte Carlo Simulation.
Frequently Asked Questions: A Comprehensive Guide to Option-Based Portfolio Insurance
What is the main topic of this thesis?
This thesis thoroughly analyzes the effectiveness and performance of option-based portfolio insurance (OBPI), specifically focusing on protective put (PP) and synthetic put (SP) strategies. It examines the theoretical foundations, practical considerations, and comparative advantages and disadvantages of these strategies in managing market risk.
What are the key themes explored in the thesis?
The key themes include option pricing theory and its application to portfolio insurance; practical implementation of PP and SP strategies; a comparative analysis of PP and SP; risk management and market risk reduction through portfolio insurance; and an evaluation of the effectiveness and efficiency of OBPI strategies.
What are protective put (PP) and synthetic put (SP) strategies?
A protective put (PP) strategy uses a put option to guarantee a minimum portfolio value. A synthetic put (SP) strategy replicates the payoff of a put option using a dynamic portfolio of assets. The thesis compares and contrasts these two approaches.
What is the role of option pricing theory, particularly the Black-Scholes-Merton model?
The Black-Scholes-Merton model is central to understanding the theoretical underpinnings of OBPI. The thesis uses this model to analyze the pricing of options and to evaluate the performance of PP and SP strategies.
What practical considerations are addressed in the thesis?
The thesis moves beyond the idealized theoretical framework to address practical considerations such as transaction costs, market imperfections, and the limitations of available options when implementing OBPI in real-world markets. A Monte Carlo simulation is used to support the analysis.
What are the advantages and disadvantages of PP and SP strategies?
The thesis provides a comparative analysis of PP and SP strategies, weighing their respective advantages and disadvantages. This includes considering factors that influence the practical application of each strategy in real-world scenarios.
What is the overall objective of the thesis?
The main objective is to analyze the efficiency and practical aspects of option-based portfolio insurance (OBPI), highlighting the differences between PP and SP strategies and the importance of considering practical refinements when implementing these strategies.
What methods are used in the thesis to analyze OBPI?
The thesis utilizes a combination of theoretical analysis, focusing on option pricing theory and the Black-Scholes-Merton model, along with practical considerations and a comparative analysis of PP and SP strategies. A Monte Carlo simulation is employed to support the evaluation of the strategies.
What are the key findings of the thesis (in general terms)?
The thesis offers a comprehensive evaluation of the efficiency and practical application of OBPI, providing insights into the relative merits of PP and SP strategies under various market conditions and practical limitations. Specific findings regarding the comparative advantages and disadvantages of each strategy are detailed within the thesis itself.
What are the keywords associated with this thesis?
Portfolio Insurance, Option-Based Portfolio Insurance (OBPI), Protective Put (PP), Synthetic Put (SP), Option Pricing, Black-Scholes-Merton Model, Risk Management, Market Risk, Hedging, Investment Strategies, Monte Carlo Simulation.
- Quote paper
- Felix Lütjen (Author), 2016, Option-Based Porfolio Insurance. Analysis of Protective Put and Synthetic Put Investment Strategies, Munich, GRIN Verlag, https://www.grin.com/document/370976
