Crash insurance for stock portfolios: What put options can really do
How can you protect your portfolio from stock market crashes? Lukas Kots' thesis for the MAS in Finance shows which option strategies work - and what they cost.
The stock market crises of recent years have shown that diversification alone is not always enough. When markets crash, almost all investments fall at the same time. Put options promise protection in such extreme situations – but as a recent MAS thesis at the University of Zurich's Finance Executive Education shows, it all comes down to the right strategy.
The problem: crises are rare, but severe
The dot-com crash, the financial crisis, and the coronavirus shock had one thing in common: in just a few weeks or months, investors lost up to 50 percent of their capital. Traditional hedging strategies such as diversification failed because in times of crisis, correlations between asset classes increase sharply, meaning that even safe investments suffer losses.
Put options offer an alternative here. They work like an insurance policy: you pay a premium and in return receive the right to sell your shares at a fixed price – even if the share loses value. But as with any insurance, the question arises: is the protection worth it?
The study: 23 years of market data put to the test
The study examined three basic strategies, which run for different terms ranging from one month to one year, on the US stock market over the period from 2000 to 2023.
Individual put options: The classic crash protection. You buy put options whose selling price is 5, 10, or 20 percent below the current market level.
Put spreads: A more cost-effective option. You buy one put option and simultaneously sell a second one with a lower strike price. This reduces costs but also limits the maximum protection.
Ladder strategies: A combination of several put options with different strike prices, which is intended to smooth the cost-benefit ratio.
The results: Protection comes at a price
Individual put options offer the strongest protection, but they also cost the most. In the crises examined, they reduced losses by up to 22 percentage points compared to an unprotected portfolio. However, investors paid between 0.3 and 1.7 percentage points in returns for this – year after year, even in calm times.
Put spreads proved to be the most efficient solution. The monthly renewable spread strategy performed well, reducing losses by around 17 percentage points while improving the risk-adjusted return compared to the unprotected stock index. The reason: selling the second option reduced costs by 50 to 80 percent.
Ladder strategies found a middle ground: they halved costs compared to simple put purchases and reduced losses by 7 to 20 percentage points – with a risk-return ratio close to that of the stock index.
Conclusion: Protection is possible, but not for free
The study confirms that put options can effectively protect portfolios against extreme losses. However, there is no such thing as free insurance. The optimal strategy depends on three factors:
- How much loss can you tolerate?
- What ongoing cost budget for protection is acceptable?
- And how much complexity can the investor handle?
Structured approaches—especially put spreads—can significantly improve cost efficiency without completely sacrificing protection. For many investors, this could be the key to sleeping more soundly in turbulent times.
Are you interested in derivatives and hedging strategies?
This MAS thesis at the University of Zurich's Finance Executive Education demonstrates in a practical way how put options and spreads protect portfolios from stock market crashes – and ideally combines the content of two certificate courses: The CAS in Derivatives teaches the technical know-how for constructing option strategies. The CAS in Investment Management provides the framework for optimally embedding these instruments in holistic portfolio construction and risk management.