Implementing equity protection strategies with options

Many pension plans have benefited from rising equity markets and may want to protect these gains. In this thought piece we build on “Protecting equity gains with equity options”1 and discuss overpaying for this insurance, accessible techniques for plans to manage the cost, and effectiveness of option protection.

Put options can protect equity gains

Plans can insure against potential losses on equities through the use of put options. By combining a traditional equity investment with some insurance (a put option) a plan can limit the amount they could lose on their equities from now to a specifi c future date. The put option will offset losses on the equity portfolio below the strike level – the level at which the insurance is set. The plan must pay a premium for this; the plan will participate in the potential equity gains less the premium paid and the value of their combined portfolio will not fall below the strike level less the premium paid.

1 For the sake of clarity throughout the document and we use the terms “protection” and “insurance” to describe the fi nancial outcomes available from a put option. Broadly speaking, in practical terms a put option will (subject to counterparty risk and net of costs) offset the losses incurred by an equity holding beyond a specifi c market level at a specifi c date and in so doing offer a form of “protection” or “insurance”.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.