Practical Applications of Pathetic Protection: The Elusive Benefits of Protective Puts

Practical Applications Summary

Should investors who are concerned about the prospect of significant declines in equity markets reduce their equity allocation or implement downside protection using derivatives? This is the topical dilemma which Roni Israelov (AQR Capital Management) tackles in Pathetic Protection: The Elusive Benefits of Protective Puts, published in the Winter 2019 Issue of the Journal of Alternative Investments. He finds that unless option purchases and their maturities coincide neatly with equity drawdowns, portfolios “protected” with put options often deliver weaker performance, larger drawdowns, and higher volatility than portfolios that simply replace a large proportion of equity with cash.

TOPICS: Options, mutual funds/passive investing/indexing, simulations, risk management