Definition
Portfolio insurance is the practice of buying options — most commonly protective puts — to cap the loss an equity portfolio can suffer in a decline. Just as a homeowner pays an annual premium to protect against fire, an investor pays an option premium to protect against a market drop.
The put gives the holder the right to sell the underlying at a fixed strike price, so once the stock falls below that strike the put gains value, offsetting the portfolio loss. The protection lasts only until the option expires.
Why it matters
How it works
An investor holding a stock buys a put at a strike near the current price. If the stock crashes, the put can be sold or exercised for a gain that offsets the holding. If the stock rises, the put expires worthless and the only loss is the premium paid — the cost of the coverage. Choosing a lower strike or a shorter expiration reduces premium but leaves a larger deductible the investor absorbs first. Like any insurance, it is most valuable bought before the storm, not during it, when premiums spike with volatility.