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Market Measures

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The Cost of Protective Puts

Market Measures

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Options are typically viewed as portfolio insurance in the traditional world of finance. Since put options grant the right to sell shares when the market crashes, they could be viewed as a hedge. However, those put options tend to trade very richly. Given their high cost, does it make sense to buy puts as portfolio protection?

The Study: Results:

Although long puts generate big profits during market corrections, the average P/L and probabilities are still stacked against you. While managing winners does improve performance, it may not be enough to provide favorable average P/L and win rates. So, while the idea of inexpensive portfolio insurance sounds great, it's not necessarily realistic. Some alternative solutions to hedging your portfolio are selling calls against long stock to reduce cost basis and trading uncorrelated products.

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