STOCKS, BONDS OPTIONS, FUTURES, AND PORTFOLIO INSURANCE - A ROSE BY ANY OTHER NAME...

Trading volume and open interest in options and futures contracts on s tock indices, equities, and interest rate instruments traded on world exchanges have experienced remarkable growth. However, this growth has been accompanied by controversy about the proper role of financial de rivatives and the potential for abuse. Prominent attention has been gi ven to losses by major corporations, broker-related short-term mutual funds, and municipal agencies. The public debate about ''derivatives'' has promoted the impression that the heart of the problem has been a proliferation of brand new ways of making bets on future stock prices, interest rates, and exchange rates. The positive functions of derivat ives as means of risk management are almost forgotten. This article sh ows that exchange-traded options are really nothing new. Rather, they are repackages of the same traditional financial instruments. The arti cle describes the practical application of the equivalence between exc hange-traded options and a traditional portfolio of stocks and bonds. This is done by demonstrating the strategies of dynamic hedging and of portfolio insurance. The first uses options to hedge against stock pr ice movements, while the second uses stocks and bonds to create ''synt hetic'' options.