What is 'Portfolio Insurance'

Portfolio insurance is either a method of hedging a portfolio of stocks against market risk by short selling stock index futures, or it can also be brokerage insurance, such as that available from the Securities Investor Protection Corporation (SIPC).

BREAKING DOWN 'Portfolio Insurance'

Portfolio insurance is a hedging technique frequently used by institutional investors when market direction is uncertain or volatile. Short selling index futures can offset any downturns, but it also hinders any gains. This hedging technique is a favorite of institutional investors when market conditions are uncertain or abnormally volatile. 

This investment strategy uses financial instruments, such as equities, debts and derivatives, combined in such a way that protects against downside risk. It is a dynamic hedging strategy that emphasizes buying and selling securities periodically in order to maintain a limit of the portfolio value. The workings of this portfolio insurance strategy is driven by buying index put options. It can also be done by using listed index options. Hayne Leland and Mark Rubinstein invented the technique in 1976 and is often associated with the October 19, 1987, stock market crash.

Portfolio insurance is also an insurance product available from the SIPC that provides brokerage customers up to $500,000 coverage for cash and securities held by a firm.

The SIPC was created as a non-profit membership corporation under the Securities Investor Protection Act. The SIPC oversees the liquidation of member broker-dealers that close when market conditions render a broker-dealer bankrupt, or puts them in serious financial trouble, and customer assets are missing. In a liquidation under the Securities Investor Protection Act, SIPC and a court-appointed trustee work to return customers’ securities and cash as quickly as possible. Within limits, SIPC expedites the return of missing customer property by protecting each customer up to $500,000 for securities and cash (including a $250,000 limit for cash only). Unlike the Federal Deposit Insurance Corporation (FDIC), the SIPC was not chartered by Congress to combat fraud. Although created under a federal law, it is also not an agency or establishment of the United States government. It has no authority to investigate or regulate its member broker-dealers. The SIPC is not the securities world equivalent of the FDIC.

Benefits of Portfolio Insurance

Unexpected developments – wars, shortages, pandemics – can take even the most conscientious investors by surprise and plunge the entire market or particular sectors into free fall. Whether through SIPC insurance or engaging in a market hedging strategy, most or all of the losses from a bad market swing can be avoided. If an investor is hedging the market, and it continues going strong with underlying stocks continue gaining in value, an investor can just let the unneeded put options expire.

 

RELATED TERMS
  1. Securities Investor Protection ...

    The Securities Investor Protection Corporation oversees the liquidation ...
  2. Insurance Industry ETF

    An insurance industry ETF invests primarily in insurance companies ...
  3. Commercial Lines Insurance

    Commercial lines insurance helps keep the economy running smoothly ...
  4. Chinese Hedge

    A Chinese hedge is a position that looks to capitalize on mispriced ...
  5. Assigned Risk

    Assigned Risk is when an insurance company is required to provide ...
  6. Admitted Company

    Admitted Company is an insurance company that is domiciled in ...
Related Articles
  1. Insights

    What Happens When A Stock Broker Goes Bust?

    While there is nothing much that can be done against the market volatility, there is a protection mechanism in place in case the broker firm runs into a financial trouble.
  2. Investing

    Bank Failure: Will Your Assets Be Protected?

    The SIPC and FDIC insure against personal financial ruin when banks or brokerages go belly up.
  3. Trading

    Hedging basics: What is a hedge?

    Hedging is a widely misunderstood strategy, but it's not as complicated as you might think.
  4. Insurance

    How To Invest In Insurance Companies

    Knowing the special circumstances that insurance companies operate under helps in evaluating whether or not a listed insurance company is a good investment and whether the economic environment ...
  5. Insurance

    12 Insurance Questions for High Net Worth Families

    High net worth families should ask themselves these 12 questions regarding comprehensive insurance.
  6. Insurance

    Are You Protected If Your Insurance Company Goes Belly-Up?

    Consumer protection against insurance company failures actually falls into the hands of state governments. How much protection do you have?
  7. Financial Advisor

    Buying a Life Insurance Policy? Read This First

    Knowing who needs life insurance, how it works and the different types of insurance can help consumers make informed decisions about this product.
  8. Investing

    3 Ways to Prepare for a Market Downturn

    No one knows when a market downturn will occur or how long it will last, so it pays to be prepared.
  9. Managing Wealth

    Avoid Future Shock By Protecting Your Portfolio With Futures

    Worried about protecting your portfolio of diversified stocks and assets? Using futures with correct strategies can help.
  10. Insurance

    Life Insurance

    Life insurance is an important component of basic financial planning. Find out how life insurance works and how insurance companies are able to profit through providing financial security to ...
RELATED FAQS
  1. How does the insurance sector work?

    Learn more about the insurance sector, a historically safe place for equity investors and the home of some of the largest ... Read Answer >>
Trading Center