Journal of Management Research

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Portfolio Hedging through Options: Covered Call Versus Protective Put


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1 Department of Business Management, Punjab Agricultural University Ludhiana 141004, Punjab
     

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The flexibility and cash outflow certainties make option contracts one of the most favored instruments for hedging purposes. Among various option-based strategies, protective put and covered call have been very popular. However, not much work has been carried out to check the relative hedging performance of covered call and protective put strategies. Moreover, research has remained largely limited to developed markets. This study compares the hedging performance of covered call and protective put strategies by utilizing total returns index for S&P CNX Nifty as a stock portfolio and hedging the same through options available on S&P CNX Nifty. It was found that both covered call and protective strategies could outperform a simple buy and hold portfolio on risk adjusted basis. Specifically, portfolio with 5% ITM short call and portfolio with 2% ITM long put had superior performance. On comparison, protective put strategy outperforms the covered call strategy both in terms of hedging effectiveness and risk adjusted returns. After adjusting for non-normality also, the portfolio with 2% ITM put option offered the best statistics.

Keywords

Portfolio Hedging, Protective Put, Covered Call
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  • Portfolio Hedging through Options: Covered Call Versus Protective Put

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Authors

Navdeep Aggarwal
Department of Business Management, Punjab Agricultural University Ludhiana 141004, Punjab
Mohit Gupta
Department of Business Management, Punjab Agricultural University Ludhiana 141004, Punjab

Abstract


The flexibility and cash outflow certainties make option contracts one of the most favored instruments for hedging purposes. Among various option-based strategies, protective put and covered call have been very popular. However, not much work has been carried out to check the relative hedging performance of covered call and protective put strategies. Moreover, research has remained largely limited to developed markets. This study compares the hedging performance of covered call and protective put strategies by utilizing total returns index for S&P CNX Nifty as a stock portfolio and hedging the same through options available on S&P CNX Nifty. It was found that both covered call and protective strategies could outperform a simple buy and hold portfolio on risk adjusted basis. Specifically, portfolio with 5% ITM short call and portfolio with 2% ITM long put had superior performance. On comparison, protective put strategy outperforms the covered call strategy both in terms of hedging effectiveness and risk adjusted returns. After adjusting for non-normality also, the portfolio with 2% ITM put option offered the best statistics.

Keywords


Portfolio Hedging, Protective Put, Covered Call

References