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A survey conducted by Eurex (Major European exchange for
derivatives) and Financial News on the use of derivatives
in the European fund industry reveals that the general trend
points to an increase in the use of options in the professional
portfolio management among institutional investors. During
volatile markets, investors tend to favor value-safeguarding
investment products. Index-based option strategies, such
as protective put strategy, are especially suitable for
this purpose. An index-based option strategy combines a
passive equity index investment with an options portfolio,
which is also passively managed. Other empirical studies
also have demonstrated that such strategies achieve a risk-return
ratio that is significantly more attractive than that of
the underlying security. In order to understand the effectiveness
of Protective Put for the Indian scenario, this paper examines
the performance of the two trading strategies: (1) Having
a long position in the S&P CNX Nifty basket; and (2)
Having a long position in stocks combined with buying put
options on the Nifty Index. Each option strategy is examined
over different maturities and option series. The analysis
was constructed by assuming a long position in European
style options on Nifty from the time they were introduced
in India on June 4, 2001. The returns using put options
are compared to the returns on S&P CNX Nifty index.
The analysis revealed significant profitability in investing
in the one-month expiry Volume-based Protective Put strategy.
Derivatives—particularly options—have come a
long way. Once considered as `niche products' are now well-established
and proven investment tools. Asset management firms can
use options as professional tools to manage their investments.
Correctly selected and deployed, they make it possible
for investors to achieve a net yield risk profile that can
be exactly tailored to their particular expectations and
chosen risk appetites. The most important use of derivatives is hedging. Hedging
is a process of reducing the risk of adverse price movements
in a security, by taking an offsetting position (elimination
or reduction of a current long or short position by making
an opposite transaction of the same security) in a related
security, such as an option or a short sale.
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