What Is Greenspan Put?

Greenspan put is the name given to a trading strategy of hedging against price risk and became popular during the 1990s and 2000s as a result of certain policies implemented by Federal Reserve Chairman Alan Greenspan during that time.

Key Takeaways

  • Greenspan put was a trading strategy popular during the 1990s and 2000s that took advantage of policies implemented by Fed Chairman Alan Greenspan.
  • Greenspan put referred to the need for protection against volatile price swings in the stock market.
  • The name refers to the strategy of buying stocks but also buying a put option to protect them because prices would likely be volatile even as they trended higher.
  • The name did not imply a concrete trading strategy so there is no way to measure the effectiveness of such a concept.
  • A historical review of the price action confirms why the perception persisted that such a strategy was necessary.

Understanding Greenspan Put

Greenspan was chairman from 1987 to 2006 and throughout his tenure he attempted to help support the U.S. economy by actively using the federal funds rate as a lever for change.
Many believed his policies encouraged excessive risk-taking in stock markets, and that investors needed to buy protection from the actions of speculators. As internet stocks fell drastically in price from 2000 to 2002, it led to profitability in trading put options and seemed to confirm the name.

Greenspan put was a term coined in the 1990s. It referred to a reliance on a stock market put option strategy that, if utilized, could help investors mitigate losses and potentially profit from deflating market bubbles. The strategy itself was not a specific investing or trading methodology, but rather a generalized notion that stocks were so volatile that an investor would do well to buy a put option while holding on to those stocks.

In practice, the idea might have advocated the notion that if you bought an internet stock, and then it dramatically rose in price over a few months, then, to preserve your gains, you would buy a put option with several months' duration to protect those shares.

A careful statistical analysis of such trading isn't possible because its rules are not particularly well defined. However, were it possible to create such a study, it would likely show that buying a put option during such times was unlikely to be more profitable during the Greenspan era than at any other time. What is true about the time period where this phrase became popular was that volatility in the markets did increase from 1997 through 2002, suggesting a connection between perceived market activity and the name.

The phrase Greenspan put suggested that many investors believed they could expect the Fed to take predictable actions that, at some point in time, would make put option derivative strategies profitable, especially in times surrounding a crisis. The chart below seems to give some historical support for why investors held that notion.

Volatility in Greenspan Era
Volatility in Greenspan Era.

This chart shows how, beginning in 1997, averaged implied volatility began to rise and remain elevated through 2004. Since this phrase was more heavily referenced in the late 1990s, it seems rational that investors and traders would hold this perception from that time forward. The fundamental factors that correspond to Greenspan's philosophy for how the Fed should accomplish its stated goals equally contribute to the use of this phrase.

Greenspan’s Actions

Greenspan took on the Chairman role with the Fed’s first actions following the 1987 stock market crisis. Greenspan lowered rates to help companies recover from the crisis and set a precedent that the Fed would intervene in times of crisis. This assumption of intervention and support from the Fed induced risk-taking that made trading and investing in general more attractive. As valuations rose beyond recognizably acceptable ranges, professional investors were less able to rationalize whether it was a sound decision to participate in some stocks—especially internet-related stocks, which were booming.

In this environment stock prices could make wild fluctuations, making put options ever more popular insurance to investors. The inflated valuations and rising prices made it difficult for seasoned investors to buy stocks without considering put-option protection.

In the early 1990s Greenspan instituted a series of rate decreases lasting until approximately 1993. Through Greenspan’s tenure there were also several instances where the Fed intervened to support exorbitant risk-taking in the stock market including market-moving events such as the savings and loan crisis, Gulf War, Mexican crisis, Asian financial crisis, Long-Term Capital Management crisis, Y2K, and especially the bursting of the dotcom bubble following the market's peak in 2000.

Source: The New York Times

Overall, the Fed under Greenspan’s direction was known for supporting a Greenspan put era that encouraged risk-taking since it was expected that interest rates would drop under any crisis. The chart above shows the general downward trend of the federal funds target rate through Greenspan's time as chairman. The effects of the Fed’s rate reductions helped investors to have the ability to borrow funds more cheaply to invest in the securities market, which added to an environment of risk-taking.

Ben Bernanke and After

On February 1, 2006, Ben Bernanke replaced Alan Greenspan as the Federal Reserve Board Chairman. Bernanke followed a similar strategy to Alan Greenspan in 2007 and 2008. The combination of rate reduction timing implemented by Alan Greenspan and Ben Bernanke has been generally attributed to supporting excessive risk-taking in the financial markets, which many believe to have been a catalyst contributing to the conditions of the 2008 financial crisis.

However, as the chart below shows, in the decade that followed the financial crisis, the results of such policies are not so obviously encouraging inordinate risk. The same policies implemented by Greenspan and Bernanke continued, in measured degree, with subsequent chairs Janet Yellen and Jerome Powell. As the chart shows, the historical results after 2008 demonstrated, on average, much less volatility in both stock and option prices than the decade that preceded it.

Volatility after Financial Crisis
Volatility after Financial Crisis.