This paper examines empirically the ability of the futures based trading strategy to replicate the returns of a protective put option, thereby creating perfect portfolio insurance. The performance of these insured portfolio is simulated over a period from January 1992 to October 1997.
In this paper five portfolio insurance strategies are examined, three of which are strategies based on option pricing model and the rest is simple strategies without option replication concept. In terms of eliminating downside risk when the market falls significantly at a level below the guaranteed minimum level, all strategies indicate to be effective and in particular simple strategies(CPPI & TIPP) show to be more effective than the other strategies. But these strategies have a limited ability of retaining upward gains.
On the other hand, option based strategies are very effective under the condition of a terminal market price being over a initial market price and detrimentally subject to a negative jump if it occurs near the expiration date and the market price is above the strike price. Therefore there is a clear trade-off between retaining upward gains and eliminating downside risk when each portfolio insurance strategy is implemented individually.
In examining the relative performance of each of the rebalancing disciplines 10 business day of time discipline and 4% of market move discipline are most effective.
This paper also shows that it is much favorable than to implement each strategy individually to flexibly make use of multiple strategies according to the market movement.
