Market Risk and Efficiency

Still Not Cheap: Portfolio Protection in Calm Markets

Topics - Market Risk and Efficiency Portfolio Risk and Performance Equities

${ numberSection } ${ text }
Still Not Cheap: Portfolio Protection in Calm Markets

Recent S&P 500 Index volatility is near all-time lows. So too is the VIX Index. Options therefore appear cheap. Many market commentators present these observations and conclude that now is a rare opportunity to buy put options for protection cheaply. But is cheap the same as good value?

This paper demonstrates that put options’ low prices during calm periods give the illusion of value. The authors write that buying an option is not a bet that realized volatility will increase; it is a bet that realized volatility will increase above the option’s implied volatility. Buying an option is expected to lose money even when volatility is low and rising if the spread between realized and implied volatility is sufficiently high.

The possibility of black swan events is an often-quoted justification for the large observed volatility risk premium. The authors assert that the frequency of black swan events required to rationalize option purchases is unreasonably large given our knowledge of extreme events. They add that investors are best served by integrating their beliefs regarding black swans to their aggregate asset allocation as opposed to opportunistically purchasing portfolio insurance at low, but not cheap, prices. This is especially the case for most investors, who have limited ability to stick with a hedging program that loses money for years while awaiting an episodic payoff.

Published in

Journal of Portfolio Management

AQR Capital Management, LLC, (“AQR”) provide links to third-party websites only as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by us of any content or information contained within or accessible from the linked sites. If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which has no control. In no event will AQR be responsible for any information or content within the linked sites or your use of the linked sites.

The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.


Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. The hypothetical performance shown was derived from the retroactive application of a model developed with the benefit of hindsight.  Hypothetical performance results are presented for illustrative purposes only.


Diversification does not eliminate the risk of experiencing investment loss.


Certain publications may have been written prior to the author being an employee of AQR.

This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.


AQR Capital Management is a global investment management firm, which may or may not apply similar investment techniques or methods of analysis as described herein. The views expressed here are those of the authors and not necessarily those of AQR.