Tuesday, May 19, 2009

Put options as portfolio insurance

A recent article on the WSJ site advocates the use of put options as portfolio insurance. The article is correct in that put options are a way of insuring your portfolio, but the basic premise that this insurance is getting cheaper is flawed. The author points to the fact that December puts on the S&P 500 with a strike of 600 have been falling in price as the market has risen. What a surprise! Options 101 will tell you that the value of a put moves in the opposite direction to value of the underlying asset. To suggest that these are "cheaper" is just silly. They are cheaper because, in effect, the amount of insurance that you are getting is declining as the index rises.