By David Blanchett

Research Overview

Recent market volatility and low bond yields have left many investors considering new ways to capture market upside while limiting their losses. One potential approach would be to use options (e.g., calls and puts), either through a direct purchase or through some type of prepackaged product, an approach we generalize with the term “protected wealth strategy” (PWS). PWSs effectively reshape the potential return distribution of an underlying financial instrument, such as the S&P 500, which some investors find attractive. Using a utility-based resampled optimization framework, we find that PWSs have the potential to improve portfolio efficiency—potentially significantly—depending on the strategy attributes and investor circumstances. This is especially true of strategies that involve selling out-of-the-money put options (i.e., buffer approaches). Before implementing any type of PWS, though, an investor needs to understand the unique risks and costs associated with each respective strategy, especially when considering a prepackaged product. A PWS can be implemented by a household (or by a financial advisor) through the direct purchase and sale of individual options. Alternatively, there are prepackaged versions available, such as a fixed indexed annuity (FIA) or registered index-linked annuity (RILA), which we collectively refer to as a prepackaged protected wealth strategy (P-PWS). An FIA provides principal protection (i.e., no downside risk) with some potential upside, while RILAs can provide more upside in exchange for the policyholders’ willingness to absorb some risk of loss.