Applied Financial Planning

How monetisation triggers provide defensiveness

BY  |  

Today's investors are at a crossroads, torn between which path to take. One direction investors can choose is sign-posted towards the potential upside arising from positive vaccine results and predicted economic recovery. The other, towards the downside, is marked by historically extreme valuations and record index levels.

To guard against any indecisiveness, investors should consider option strategies which will allow them to consider both paths, in other words they can obtain base-case positioning for their portfolios while also hedging for the alternative outcome.

Typically, when considering simple, defensive option-based approaches, investors buy and hold vanilla options to maturity while insuring against a downturn over the holding period; irrespective of whether the market falls below the strike.

As an alternative, this paper investigates how investors can harness monetisation to take advantage of the current mark-to-market fluctuations arising from optionality supply and demand, as well as the direction of the underlying market. It then examines how monetisation parameter choices impact the relative performance of the program by first modelling for a 90/80 put spread followed by a 95/85 put spread.

The paper then suggests the ability of a monetised option portfolio to outperform a buy and hold option portfolio depends on the nature of the drawdown, particularly around its depth and eventual reversion.

Over the long run, investors can use monetisation programs to add value by taking profits when market movements allow.