Portfolio insurance is a method of hedging a portfolio of stock

Stock

The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...

s against the market risk

Market risk

Market risk is the risk that the value of a portfolio, either an investment portfolio or a trading portfolio, will decrease due to the change in value of the market risk factors. The four standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices...

 by short selling stock index futures

Futures contract

In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...

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This hedging technique is frequently used by institutional investor

Institutional investor

Institutional investors are organizations which pool large sums of money and invest those sums in securities, real property and other investment assets...

s when the market direction is uncertain or volatile

Volatility (finance)

In finance, volatility is a measure for variation of price of a financial instrument over time. Historic volatility is derived from time series of past market prices...

. Short selling index futures can offset any downturns, but it also hinders any gains.

Portfolio insurance is an investment strategy where various financial instruments like equities

Equity (finance)

In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...

 and debt

Debt

A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...

s and derivative

Derivative

In calculus, a branch of mathematics, the derivative is a measure of how a function changes as its input changes. Loosely speaking, a derivative can be thought of as how much one quantity is changing in response to changes in some other quantity; for example, the derivative of the position of a...

s are combined in such a way that degradation of portfolio value is protected. It is a dynamic hedging strategy which uses stock index futures. It implies buying and selling securities periodically in order to maintain limit of the portfolio value. The working of portfolio insurance is akin to buying an index put option, and can also be done by using listed index options.

The technique, invented by Hayne Leland and Mark Rubinstein

Mark Rubinstein

Mark Edward Rubinstein is a leading financial economist and financial engineer. He is currently Professor of Finance at the Haas School of Business of the University of California, Berkeley, where he is involved in teaching courses in the , an academic program that is focused on equipping...

 in 1976, is often associated with the October 19th, 1987 stock market crash

Black Monday (1987)

In finance, Black Monday refers to Monday October 19, 1987, when stock markets around the world crashed, shedding a huge value in a very short time. The crash began in Hong Kong and spread west to Europe, hitting the United States after other markets had already declined by a significant margin...

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