Does Buying Puts Actually Work?

My last post looked at buying puts for portfolio insurance. The question remains, does put buying for portfolio insurance actually work? To answer this conclusively one needs to do exhaustive research on multiple market declines and associated put option behavior. Here, we can look at one example which can give us a clue to answer the larger question.

Let's consider an idealized example from last year. Suppose last year at this time, you owned 100 shares of the SPY on April 23, 2018 and you bought the at-the-money put for put insurance.

4/23/2018 SPY closing price: $266.56; SPY at-the-money 12/31/2018 266 put: $12.315 = 4.1906% of SPY share price.

12/31/2018  SPY closing price: $249.92.

Thus at year end, your put expired at an idealized value of $16.08 (266-249.92, assuming a perfect exercise and cover of the short stock position at $266).

How did the portfolio insurance work out? With NO insurance your SPY position lost $16.64 (excluding dividends) or 6.2425%. WITH insurance, you lost 56 cents (-16.64+16.08) or .21% of your capital. There is no coincidence that the loss equals the 56c difference between the stock and the strike price.

Feel free to post comments.

Disclaimer: Posts are for education only and not investment advice, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors.