How a Monthly Protective Put Strategy Trades Upside for Crash Protection
Summary
The note explains the CBOE Put Protection Index as a tail-protection strategy: it holds exposure to the S&P 500 and buys a monthly put struck out of the money. The put premium reduces returns in ordinary markets, while the option can cushion losses when the index falls sharply. The strategy can have a positive return when equity gains exceed the cost of the hedge; with a flat index, the premium can produce a loss.
The answer analyzes historical monthly option-period returns using more than thirty years of CBOE data and compares PPUT with the price-only SPX index. It reports lower average annualized returns and volatility for PPUT, along with a less severe worst monthly loss, while PPUT had positive returns in fewer months. These figures illustrate the tradeoff in the sample, not a guarantee of future results. Returns also depend on option premiums, which can rise after crashes, and the comparison omits SPX dividends.
Key ideas
- PPUT combines S&P 500 exposure with a recurring out-of-the-money put hedge.
- Put premiums reduce returns and can leave the strategy negative when equity gains do not cover the hedge cost.
- The put can cushion sharp market declines when losses pass the strike threshold.
- Historical data showed lower returns and volatility than the compared price-only index in the analyzed sample.
- The reported performance depends on historical option costs and excludes dividends from the SPX comparison.
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Full text
# When does the CBOE Put Protection Index (PPUT) make profit?
# When does the CBOE Put Protection Index (PPUT) make profit?
In my question, as stated in the title, I aim to understand when the strategy of the CBOE Put Protection Index (PPUT) makes profit; particularly during which market conditions.
Given the description of CBOE: that the PPUT index holds a long position indexed to the SP500 and buys a monthly 5% OTM-Put option as hedge, what does that mean in terms of making profit? How does it make the profit?
## Answer by Alex C (score 5, accepted)
https://quant.stackexchange.com/a/36722
The PPUT strategy is an example of a "tail protection strategy". The objective is to have a return somewhat similar to the return of the S&P 500 but with better performance during "crashes" (sharp down moves in the S&P). The strategy buys puts, which cost money (i.e. detract from returns) but are helpful when the SP drops more than 5% (improving the return in that case, i.e cushioning the fall).
As berkobay said, the strategy makes money as long as the rise in S&P exceeds the cost of the puts. As we will see later the average cost of the puts is about 10 or 20 basis points per month (although it can be much higher at times, such a after a crash), so for example when the S&P is up 3% in a month the PPUT might be up 2.8%, if the S&P is unchanged, the PPUT return might be -0.20% and so on.
Let's use the > 30 years of data provided by the CBOE, and look at returns during each "option-month", where an "option-month" goes from the 3d Friday of a calendar month to the 3d Friday of the next month. For example "option-September 2017" goes from 2017/08/18 to 2017/09/15.
Here are basic statistics for the monthly returns for the PPUT strategy and for the SPX index (recall that the SPX index does not include dividends):
```
PPUT SPX
Monthly Annualized Monthly Annualized
N 374 31.17 N 374 31.17
Avg 0.006327 0.075919 Avg 0.007394 0.088724
Stdev 0.03595 0.124533 Stdev 0.045541 0.157759
Frac>=0 0.596257 Frac>=0 0.625668
Max 0.125122 Max 0.139962
95%tile 0.065314 95%tile 0.072122
Min -0.07937 Min -0.25061
5% tile -0.05982 5% tile -0.06378
```
As you can see the PPUT has lower returns per year (7.59% vs 8.87%) but with lower volatility (12.45% per year vs 15.78%). PPUT is less risky, as we can more clearly see by comparing the worst (i.e. tail) outcomes. For example the worst monthly return for SPX during this period was -25% (during the option-month from September 19, 2008 to October 17, 2008), while the worst possible outcome for PPUT was "only" -7.9).
To answer your first question the PPUT makes money a decent percentage of the time (59% of months) but the SPX makes money 62% of he time.
Finally a chart of the PPUT and SPX cumulative returns visually confirms these statistics: a better return for the SPX, but a smoother ride for the PPUT.
Many more statistics could be computed, of course: I leave those up to you.Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.