Hedging a Portfolio with Index Puts Using Beta and Payoff Analysis
Summary
The article illustrates how a put option can limit downside on an equity holding and shows how the premium changes the portfolio’s payoff. It first models a position in an index-tracking fund, identifying the price level associated with a chosen loss and comparing unhedged and put-hedged outcomes across possible ending prices. The example makes the option’s strike and upfront cost central to the protection calculation.
For a portfolio containing several stocks, it estimates sensitivity to the index by regressing portfolio returns on index returns over a rolling window. The latest beta is then used to translate portfolio value into an approximate number of index shares to hedge, providing a starting point for sizing an index-option hedge. The treatment is illustrative rather than a full hedge optimization: it does not establish that the sample portfolio is representative or assess option Greeks, volatility changes, expiry choice, basis risk, or changing correlations. The article frames the decision around the portfolio’s risks, the trader’s edge, and risk tolerance.
Key ideas
- A protective put’s payoff below its strike depends on the strike, initial asset price, and option premium.
- A regression of portfolio returns on index returns can provide an estimate of market beta.
- A beta-scaled index exposure offers a rough basis for estimating hedge size.
- Index options can leave basis risk when the portfolio does not track the index closely.
- Hedge choice should reflect the portfolio’s risks and the investor’s risk tolerance.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.