Is There a Less Expensive Hedge Than a Protective Put ?

In this post we examine different hedging strategies using instruments on the same underlying.  Our goal is to investigate the cost, risk/reward characteristics of each hedging strategy. Knowing the risk/reward profiles will allow us to design a cost-effective portfolio-protection scheme.

The hedging strategies we’re investigating are:
1-NO HEDGE: no hedging is performed. The asset is allowed to evolve freely in a risky world. This would correspond to the portfolio of a Buy and Hold investor.
2-PPUT: protective put. We buy an at the money (ATM) put in order to hedge the downside. This strategy is the most common type of portfolio insurance.
3-GAMMA: convexity hedge.  We buy an ATM put, but we then dynamically hedge it. This means that we flatten out the delta at the end of every day.




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