Options as an insurance - Why is it not working? Or does it? VAR 5% How?

thecoder

thecoder

We are taught that Put options can be used as an insurance. But is it really true? :)

Let's say I have a very normal stock in my portfolio and want to protect it (ie. "insure it") a year long so that its account value never (or at least at the end) falls below 95% of its current value, even if the stock falls more than 5%.

How can this be done with options? The current stock price shall be $100 and its historical volatility is say 30%, as well the implied volatility (IV) of the options (Put, Call) for the ATM strike.

Now, if I buy an ATM Put option then it costs about $11.92, but obviously this doesn't give a 95% protection, only a 88.08% protection (100-11.92), ie. one can lose 11.92% whereas one wanted to risk max. 5%.

So, how else to set up such an insurance to risk max. 5% (ie. 95% protection)?

Edit / Update:
I begin to realize that for the said timeframe of a year a 95% protection is not possible. The best insurance one can get is 88.08% protection.
 
Last edited:
thecoder said:
We are taught that Put options can be used as an insurance. But is it really true? :)

Let's say I have a very normal stock in my portfolio and want to protect it (ie. "insure it") a year long so that its account value never (or at least at the end) falls below 95% of its current value, even if the stock falls more than 5%.

How can this be done with options? The current stock price shall be $100 and its historical volatility is say 30%, as well the implied volatility (IV) of the options (Put, Call) for the ATM strike.

Now, if I buy an ATM Put option then it costs about $11.92, but obviously this doesn't give a 95% protection, only a 88.08% protection (100-11.92), ie. one can lose 11.92% whereas one wanted to risk max. 5%.

So, how else to set up such an insurance to risk max. 5% (ie. 95% protection)?

Edit / Update:
I begin to realize that for the said timeframe of a year a 95% protection is not possible. The best insurance one can get is 88.08% protection.
More...

There are so many different ways to construct this for a exact 5% but in the interest of time and my Saturday, lets get some more clarity first. Are you also interested at the same time to keep the upside, or just preserve 95% of the value? How much on the upside do you want to keep? Look at the 110 calls in one year and sell those as well so you have collar, with a ceiling 10% up and a floor 5% down.
 
thecoder said:
We are taught that Put options can be used as an insurance. But is it really true? :)

[...]

Edit / Update:
I begin to realize that for the said timeframe of a year a 95% protection is not possible. The best insurance one can get is 88.08% protection.
More...

What you have not yet been taught is the concept of implied volatility. The price of an option, and thus the level of "protection" depends on it - and 95% is within the range of possible values. A quick scan turns up GBIL (100.07) with an IV of 2.9%; the ATM put is priced 0.75x1.30 for the 173d tenor.
 
Not only is your insurance only 88%, the stock also has to go higher then 112 to make a profit.

You can also write deep ITM calls (e.g. 80 delta) agains your stock. You will lower you cost price and your stock can go down 15/20% before you have losses. But you also limit your profit.
Max profit is then theta received + dividend in a year.
 
As @W-M-A wrote, it's possible by using a Collar (--> https://en.wikipedia.org/wiki/Collar_(finance) ) and accepting the capping at both the down side and the up side. For example this one using Call strike 115 and Put strike 100: https://optioncreator.com/stjm4i0
There are also many other strike combinations possible that give the desired P/L, albeit capped at both sides.

Another example uses Call strike 100 and Put strike 90: https://optioncreator.com/sttkt4m

Also, as @dorietrading wrote, one can also use an ITM option with one of the legs.
 
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thecoder said:
@BlueWaterSailor, thx, do you happen to know why YahooFinance (--> https://finance.yahoo.com/quote/GBIL/options?p=GBIL ) doesn't list GBIL options? It just says "Options data is not available"
More...

I'd imagine they only list a subset of the entire market. We're outside RTH, but here's the chain:

upload_2021-10-23_11-26-55.png
 
thecoder said:
We are taught that Put options can be used as an insurance. But is it really true? :)

Let's say I have a very normal stock in my portfolio and want to protect it (ie. "insure it") a year long so that its account value never (or at least at the end) falls below 95% of its current value, even if the stock falls more than 5%.

How can this be done with options? The current stock price shall be $100 and its historical volatility is say 30%, as well the implied volatility (IV) of the options (Put, Call) for the ATM strike.

Now, if I buy an ATM Put option then it costs about $11.92, but obviously this doesn't give a 95% protection, only a 88.08% protection (100-11.92), ie. one can lose 11.92% whereas one wanted to risk max. 5%.

So, how else to set up such an insurance to risk max. 5% (ie. 95% protection)?

Edit / Update:
I begin to realize that for the said timeframe of a year a 95% protection is not possible. The best insurance one can get is 88.08% protection.
More...
%%
SURE can do it.
BUT like any insurance, you want to get rich enough to self insure some stuff\because the lower your deductable, the more you enrich the insurance co................................................
ME I use stuff like SPXS, spxu...........................
:caution::caution::caution: Any derivative could be better/ than say a good insurance co like State Farm; i can buy plenty,of ETFs if i want, in SEPT [selling season]
Most insurance companies would not even want to insure hi risk like that/certain exceptions apply.
Hospital insurance is so screwed up/wasteful with 100% , no deductable\ NO incentive to be careful .
 
thecoder said:
We are taught that Put options can be used as an insurance. But is it really true? :)

Let's say I have a very normal stock in my portfolio and want to protect it (ie. "insure it") a year long so that its account value never (or at least at the end) falls below 95% of its current value, even if the stock falls more than 5%.

How can this be done with options? The current stock price shall be $100 and its historical volatility is say 30%, as well the implied volatility (IV) of the options (Put, Call) for the ATM strike.

Now, if I buy an ATM Put option then it costs about $11.92, but obviously this doesn't give a 95% protection, only a 88.08% protection (100-11.92), ie. one can lose 11.92% whereas one wanted to risk max. 5%.

So, how else to set up such an insurance to risk max. 5% (ie. 95% protection)?

Edit / Update:
I begin to realize that for the said timeframe of a year a 95% protection is not possible. The best insurance one can get is 88.08% protection.
More...

Do you need to actually own the stock?
 
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