OBPI (Option-Based Portfolio Insurance) and CPPI (Constant Proportion Portfolio Insurance) are risk management strategies that you can use to protect your security portfolio, or your client’s portfolio. Each strategy involves different techniques, so let’s discuss them separately:

1. Option-Based Portfolio Insurance (OBPI):

Option-Based Portfolio Insurance involves the use of options to protect a portfolio from downside risk. Here’s a general approach:

a. Purchase of Put Options:

• Invest in a diversified portfolio of assets.
• Simultaneously, buy put options on the same underlying assets.
• Put options give you the right (but not the obligation) to sell the underlying asset at a predetermined price (strike price) within a specified time frame.
• Even a small investment in an option can help to protect the downside. But if it’s too small, you just waste everyone’s time discussing and plotting the option purchase. More than often, the cost of the portfolio management team’s time is higher than the benefit.

b. Tailor the Option Strategy:

• Customize the number and maturity of put options based on the desired level of protection.
• Adjust the strike prices to set the level at which protection kicks in.

c. Reevaluate and Adjust:

• Regularly reassess the portfolio and the option positions.
• Adjust the strategy based on changes in market conditions, portfolio composition, or risk tolerance.
• You can use different time spans and weightings
• If you are doing this for a client, note his/her preferences and confirm them in writing once you’ve set up the initial strategical lay-out of their portfolio. Clients have home bias and fall in and out of love with stocks. This is a perfect place to include your client’s wishes and the notes will come in handy once you review the portfolio performance.

2. Constant Proportion Portfolio Insurance (CPPI):

Constant Proportion Portfolio Insurance is a dynamic asset allocation strategy designed to limit downside risk while participating in potential upside gains. The strategy involves the following steps:

a. Set a Floor and a Multiplier:

• Establish a floor value for the portfolio (the minimum acceptable value).
• Set a multiplier that determines the degree of participation in upside movements.

b. Dynamic Asset Allocation:

• Allocate assets dynamically between a “safe” asset (e.g., cash or fixed-income securities) and a “risky” asset (e.g., equities).
• The allocation is based on the current value of the portfolio relative to the floor.

c. Rebalance Periodically:

• Periodically rebalance the portfolio to maintain the desired asset allocation.
• Adjust the allocations based on changes in the portfolio value and the floor.

d. Adjust the Strategy as Needed:

• Investors can customize the strategy by changing the parameters such as the floor, multiplier, and asset classes used. This can also be a huge waste of time. Remember to compare the performance of the portfolio as tampered vs left alone. In most cases, the portfolio manager has wasted time and added transaction costs by applying CPPI too frequently.

How to Take Advantage:

1. Diversify Your Portfolio:

   • Diversification across different asset classes can enhance the effectiveness of risk management strategies.

2. Regularly Monitor and Rebalance:

   • Stay vigilant about the market conditions and the performance of your portfolio.
   • Rebalance the portfolio and adjust option positions as needed.

3. Understand Costs and Risks:

   • Be aware of the costs associated with implementing these strategies (e.g., option premiums).
   • Understand that no strategy can completely eliminate risk, and there may be trade-offs between protection and potential returns.

4. Consider Professional Advice:

   • Given the complexity of these strategies, consider seeking advice from financial professionals who specialize in risk management and portfolio protection.

Remember, both OBPI and CPPI are risk management tools and do not guarantee profits or protect against all losses. They should be used based on your risk tolerance, investment goals, and market outlook. Additionally, it’s crucial to regularly reassess and potentially adjust these strategies based on changing market conditions. But if you need to convince a client that they need your portfolio management service, you should definitely bring up the possibility of using both OBPI and CPPI. Let the client decide, document the decision and your client will be happy regardless of the portfolio performance.