Abstract
This paper examines the effectiveness of using dividend yield to fund hedging protection for an S&P500 equity portfolio. We construct a hedged portfolio that consists of the S&P500 index but uses the dividend yield to purchase put option protection for hedging risk. We then compare the risk and return of the hedged S&P500 portfolio to that of an unhedged S&P500 portfolio. The trade-off reduced returns compared to the overall risk reduction are also measured. Results indicate that this risk-management strategy could be appealing to a large contingency of investors seeking down-side protection at a modest cost that is self-funded from dividends.
Highlights
This paper considers the degree to which the dividends derived from a market portfolio can provide an ample basis for the implementation of an impactful insurance strategy using commonly available instruments
Having established the viability of Options-Based Portfolio Insurance (OBPI) as a tool to mitigate the risk associated with the market index, we considered the adequacy of the portfolio dividend yield as the funding source for our theorized option strategy
This paper builds on the OBPI literature by considering the use of dividends to fund the implementation of a portfolio hedging strategy
Summary
This paper considers the degree to which the dividends derived from a market portfolio can provide an ample basis for the implementation of an impactful insurance strategy using commonly available instruments. [See descriptive stats in Table 1 and Table 2 below.]We measure the risk-return tradeoff by means of the coefficient of variation in which the standard deviation of returns is divided by the average of the returns This analysis provided us with the ability to assess: (i) the extent to which a protective strategy limits downside risk, (ii) the cost of implementing this form of portfolio insurance in terms of the forgone return during periods of robust market performance, and (iii) the degree to which dividend-funded hedging impacts the relationship between risk and return
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