form of hedging that uses STOCK INDEX FUTURES contracts and index options
to limit the downside risk of holding a diversified portfolio of common
stocks. PI programs are offered
by major banks, brokerage firms, insurance companies, and other financial
institutions. They have attracted
many large institutional holders of common stocks like pension funds and
the stock market declines, holders of common stocks traditionally begin
to move some portion of their assets out of stocks and into cash to protect
themselves against further declines in the market.
PI programs attempt to hedge against the possibility of a market
decline by selling stock index futures contracts or stock index options
(buying stock index put options).
The more the market falls, the more futures and options contracts
are sold by PI programs. If
the market continues to fall, the rise in the value of the portfolio's
futures and options positions cushions the decline in the value of the
portfolio's common stocks. PI
managers believe that such HEDGING programs using futures and options
involve lower transaction costs and provide greater liquidity than the
traditional method of actually selling stocks and buying Treasury bills.
insurance differs from true insurance in that it does not guarantee protection
in the event of a market downturn.
In the market crash of