Portfolio Insurance

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What Is Portfolio Insurance?

Portfolio insurance was an automated hedging strategy popular in the 1980s that aimed to limit a portfolio's losses by selling stock index futures as prices declined. In theory, the futures sales would offset falling stock values, protecting investors against a downturn much like an insurance policy. In practice, because many large investors followed the same rules-based approach, the strategy told them all to sell at once as the market dropped. This automated selling is widely cited as having amplified the selling pressure on Black Monday, October 19, 1987, when the Dow Jones Industrial Average fell about 22.6% in a single session.

Why It Matters

Portfolio insurance matters as a case study in how a tool meant to reduce risk can magnify it for the market as a whole. The Brady Commission, which investigated the 1987 crash, particularly emphasized the interaction between portfolio insurance and stock index futures selling as central to why the crash spread so quickly, as sales in the futures and stock markets fed on each other. The episode reshaped thinking about automated, correlated trading strategies and helped prompt reforms such as circuit breakers and restrictions on program trading. It remains a classic example of how strategies that are individually rational can become collectively destabilizing.

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