Paying To Protect Your Portfolio Seems Cheap

Paying To Protect Your Portfolio Seems Cheap
Stéphane Renevier, CFA

about 3 years ago1 min

  • The chart shows the difference between the 3-month implied volatility and the 1-month realized volatility across five asset classes.
  • Implied volatility shows investors' expectations of an asset's future volatility, based on option prices, while realized volatility is based on an asset's recent history.
  • When investors buy an option, they effectively “pay” implied volatility and “receive” realized volatility at some point in the future – and since implied volatility is generally higher than realized volatility, option buyers pay a “premium”.
  • But because the gap between implied and realized volatility is currently at a record low, it's relatively cheap to buy such options that help protect your portfolio (such as "puts" that give you the right to sell) should volatility unexpectedly rise.
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