The Returns and Risks of Alternative Put-Option Portfolio Investment Strategies

This is the second in a series of analyses we have prepared based on simulations of a variety of portfolio strategies over a significant period of time. The first of these analyses' examined the fully covered call-option-writing strategy and the buying strategy which combines purchase of call options and commercial paper. In the study presented here, we examine the put-writing strategy and the buying strategy which combines the purchase of put options and the underlying stocks. As a preface to the simulations, we analyze the quantitative discrepancies between the parity model of put pricing and a model which takes into account the possibility of early exercise of the put. In connection with this analysis, we simulate the returns to the conversion strategy which combines the purchase of put options and the underlying stocks with the simultaneous sale of the corresponding call options. As in earlier on call-option strategies, we find in this study that investors can use uncovered putoption-writing and protective put-optionbuying strategies to produce patterns of returns for investment portfolios, not reproducible by any simple strategy of combining stock with fixed-income securities. Put options are viewed as term insurance, insuring against a loss in value of underlying stock: investors sell insurance by using the uncovered put-writing strategies and investors buy insurance protecting the value of stocks within a portfolio by using protective put-optionbuying strategies. No put strategy or call strategy can dominate any other strategy if options are priced correctly. Although there is no single best strategy for all investors, they are not indifferent among strategies because the patterns of returns differ. We, therefore, show these important patterns of returns on put-option strategies not only using single stocks but also using portfolios of stocks. *This research was financed, in part, by grants from Donaldson, Lufkin, & Jenrette, New York; the Center for Research in Security Prices, University of Chicago; and the National Science Foundation, Washington, D.C. 1. Merton, Scholes, and Gladstein (1978). In the present paper, all references to our earlier paper are to this study.