Publication Type

Journal Article

Version

submittedVersion

Publication Date

11-2023

Abstract

The authors find that a simple heuristic of sorting liquid equity options by dollar price to construct a portfolio of cheap put options leads to a surprisingly robust hedge for tail risk – the superior performance holds even when compared against more advanced empirical strategies. Further investigation reveals the asymmetry in market correlation under different market conditions as the mechanism of this robust hedging performance. The cheap options selected by the heuristic comprises of stocks with diverse firm characteristics. The correlation spike accompanying tail risk events leads to the majority of these put options moving into-the-money (ITM), thus compensating the losses incurred on a benchmark S&P 500 index holding. On the other hand, during normal market conditions, the lower market correlation leads to some of these put options expiring ITM, mitigating the portfolio drag effect through diversification.

Keywords

tail risk, portfolio insurance, risk management, portfolio management, hedging, option markets, index options, volatility risk premium

Discipline

Finance and Financial Management | Portfolio and Security Analysis

Research Areas

Finance

Publication

Journal of Portfolio Management

Volume

50

Issue

1

First Page

106

Last Page

119

ISSN

0095-4918

Identifier

10.3905/jpm.2023.1.539

Publisher

Institutional Investor Inc

Copyright Owner and License

Authors

Additional URL

https://www.pm-research.com/content/iijpormgmt/50/1/106

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