http://www.ifid.ca/pdf_workingpapers/WP2005JUNE20.pdf
Exhibit #14 provides an example of how this would work for a retirement
portfolio. Imagine that at retirement you decide to allocate your $100 nest egg
(which can arbitrarily be scaled up or down) and consume $4 per year from this
nest egg. If all of the money is invested in equity-based products, the simulation
results suggest that the probability of retirement ruin is 7.3% for a male (and
8.4% for a female, as per Exhibit #15). But, if you or your client purchase a 3-
month put option that is 5% out-of-the-money, which means that the strike price
is initially at $95, and you fund this purchase by selling a call option that is 6.6%
out of the money, the put/call combination will reduce the dispersion of your
portfolio and will reduce the probability of ruin to 1.5% for a male and 2.4% for a
female.
Essentially, we obtain this improvement in probability because we have
removed the very large negative returns from all scenarios, thus increasing the
chances that your initial nest egg is sufficient to maintain your desired standard
of living. We emphasize, though, that this “collar strategy” is not a free lunch
since large negative returns are reduced at the expense of reducing the upside
potential of the portfolio. This is yet another manifestation of the universal tradeoff
between financial risk and return. Thus, although the portfolio's income will
"last" longer by "delaying its date" with zero, the portfolio will not grow or increase
in value as rapidly as the un-collared or unprotected portfolio. A sample path of
the wealth in retirement with and without “collar protection” can be seen in Exhibit
#16.
</snip>
intercst
Exhibit #14 provides an example of how this would work for a retirement
portfolio. Imagine that at retirement you decide to allocate your $100 nest egg
(which can arbitrarily be scaled up or down) and consume $4 per year from this
nest egg. If all of the money is invested in equity-based products, the simulation
results suggest that the probability of retirement ruin is 7.3% for a male (and
8.4% for a female, as per Exhibit #15). But, if you or your client purchase a 3-
month put option that is 5% out-of-the-money, which means that the strike price
is initially at $95, and you fund this purchase by selling a call option that is 6.6%
out of the money, the put/call combination will reduce the dispersion of your
portfolio and will reduce the probability of ruin to 1.5% for a male and 2.4% for a
female.
Essentially, we obtain this improvement in probability because we have
removed the very large negative returns from all scenarios, thus increasing the
chances that your initial nest egg is sufficient to maintain your desired standard
of living. We emphasize, though, that this “collar strategy” is not a free lunch
since large negative returns are reduced at the expense of reducing the upside
potential of the portfolio. This is yet another manifestation of the universal tradeoff
between financial risk and return. Thus, although the portfolio's income will
"last" longer by "delaying its date" with zero, the portfolio will not grow or increase
in value as rapidly as the un-collared or unprotected portfolio. A sample path of
the wealth in retirement with and without “collar protection” can be seen in Exhibit
#16.
</snip>
intercst