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Tuesday, December 15, 2020

Stock Market Insurance

The cost of 1 year stock insurance since 2005 is presented below:

SPY = S&P 500 ETF 
Put Cost as Percentage of SPY

Source: T. D. Ameritrade ThinkBack platform.

Above are the year-end closing prices of SPY and cost of the closest 1 year at-the-money put*, as a percentage of SPY, since SPY options started trading in 2005. Note that the SPY Return, our proxy for a stock market portfolio, averaged 9% with the largest drawdown of 38% in 2008. The "married put" insured portfolio, Return with Put, averaged 4% and reduced the portfolio loss by 30% in 2008. The married puts paid off in the down year. 

All told, just like real insurance, premiums (put prices) vary each year and its up to the buyer to judge their worth. In my view, option sellers are very shrewd and usually price put option insurance so its NOT worth buying.

*Two examples from the above table: 

Up year: On 12/31/2018 SPY closed at $249.92. The at-the-money put closest to covering the coming year was the 12/20/2019 250 put which closed at $18.185 or (18.105/249.92 =) 7.3%. On 12/31/2019 SPY closed at $321.86 for a return of 28.8%. The return less the cost of the put was 21.5%. Since SPY closed above the $250 strike price, the put expired worthless. 

Down year: On 12/31/2007 SPY closed at $146.21. The at-the-money put closest to covering the coming year was the 12/31/2008 $146 put which closed at $11.07 or (11.07/146.21 =) 8.0%. On 12/31/2008 SPY closed at $90.24 for a loss of -38.3%. The put stopped the loss at the $146 strike price so the net loss was only -8.1% (=11.70 cost of put +.21 difference between stock and strike = 11.91/146.21.).

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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.

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