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Describe how call options written on stock index options could be used to provide portfolio insurance.

Describe how call options written on stock index options could be used to provide portfolio insurance.

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Answer #1

Solution:

When we write a call option then we get an option premium and when the value of the underlying asset (stock, index, etc.) is less than the strike price at the time of the expiry then the option expires worthless, and we earn the option premium.

How this act as insurance:

When we have stocks in the portfolio then portfolio value increases when the price level of stocks increases. When the market falls then the portfolio value will decrease, in this case when we write options then in the falling market, we can earn the call option premium.

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