Portfolio insurance is a financial practice designed to protect investors from financial risks associated with investing. It can involve selling index futures or using put options to limit losses. Brokerage insurance is another form of portfolio insurance. Despite this, investing is still risky and new investors should consider taking classes and working with an investment advisor.
The term “portfolio insurance” is used to refer to various financial practices that are designed to insulate investors from the financial risks associated with investing. The concept of portfolio insurance was developed in the late 1970s and is believed to have played a role in the stock market crash of 1987, the infamous “Black Monday” in which global stock markets crashed. Today, portfolio insurance is much less used.
There are several ways insurers can protect themselves with portfolio insurance. An option involves selling index futures when stock prices fall, while still holding the stock itself. As prices continue to fall, futures can be bought back at a lower price, generating a profit that reduces and limits losses. Portfolio Insurance can be configured to do this automatically, ensuring that response is quick when prices are highly volatile.
Another choice is to use put options, which give people the right to sell their shares at a specific price. People are not required to exercise put options, but they can if prices are falling and they feel they should unload the stock before the price falls further. In a simple example of how put options work, someone could buy 100 units of any currency used, with a put option for 90. Whether the stock’s price is 200 units or 20 units, the buyer may choose to sell to 90 with the put option. Thus, when prices fall, sellers can exercise the put option to exit the investment with minimal loss.
People may also sometimes refer to brokerage insurance as portfolio insurance. In this case, the brokerage itself is insured against losses, protecting clients from losses when the market is volatile. This special insurance product is offered by various finance companies and insurance companies. These companies, in turn, spread the risk of their insurance product across a large pool to limit liability and hopefully avoid incurring a loss if a payment is required.
Even with portfolio insurance, investing is risky. The riskier it is, the greater the potential rewards. This can be a problem for new investors who may think they can make easy money and only realize they are in trouble after the market has started to decline. People interested in investing should consider taking classes and working with an investment advisor to learn the ropes before branching out on their own.
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