Robert Kanter: Portfolio insurance for Individuals

January 1987
FUTURES
by Susan Abbott, senior editor

Robert Kanter believes individual traders should take the same attitude as portfolio managers.

"Adjusting the risk of anyone's portfolio is something that has to be done in this day and age," he believes.

What he's talking about - and doing - is bringing the concept of "portfolio insurance" to an individual.

Kanter, a veteran trader of 28 years, is managing general partner of Arbco, a New York-based trading and investment management firm he founded in 1979. After 15 years as a partner with L.W. Herman and Co., one of the largest specialist forms at the American Stock Exchange, Kanter formed R. Kanter Securities in 1975 to trade stock options at the Chicago Board Options Exchange (CBOE). In 1977 he joined Shearson Hayden Stone and spent two years as an account executive.

Unlike the common premise of portfolio insurance used by large, institutional investors, Kanter believes in buying "insurance" on market strength and selling "insurance" on market weakness. He believes most institutional portfolio insurance programs wait until market weakness appears to buy insurance - meaning sell futures, buy puts or sell calls. They sell their insurance - or reverse those futures and options positions - after the market already has shown strength.

"I think Sept. 11-12 (when the Dow Jones Industrial Average fell nearly 150 points) changed some thoughts on portfolio insurance," Kanter says. "Everyone tried to do the same thing at the same time, and many people probably bought the insurance at the lows."

He believes his trading background will help keep individuals from experiencing that kind of pain.

"If the market's higher three or four days in a row, I'd look at buying insurance and hope I'm wrong," he says.

The biggest hindrance in an individual's taking advantage of the portfolio insurance concept is size: It's unlikely an individual will own all the Standard & Poor's (S&P) 500 Index stocks. "Therefore, basis risk is most important to define and defend," Kanter says.

To accomplish that, clients ask Kanter to readjust their portfolios to more closely track the index. Then, to protect against market risk, Kanter can use individual stock options or an index option. He favors S&P 100 Index options (OEX) at the CBOE for those with portfolios around $100,000, an amount he considers minimum to employ the insurance technique effectively.

However, he adds that many investors are confident of their stock picks and only want to protect against a general market decline. In both instances, Kanter wants to make sure customers realize they are buying term insurance with the seller's option to renew.

"The price for a future policy is not determined until the current one expires, and it is based on the volatility charge and level of the market at the time," Kanter says.

Therefore, he uses his trading skills to roll "insurance" forward. He watches a market's historical volatility carefully and knows where premium charges currently stand. He also watches price for clues in market direction.

That attitude, plus 23 rules of trading to which he subscribes, are detailed on a videotape used to train traders for the firm's in-house arbitrage trading. New traders must transcribe the entire six hours of tape as part of their training. Those rules include having a game plan, buying or selling at your preferred price, having an "exit door" before you trade, buying weakness/selling strength and not standing in front of a moving train.

Another important rule Kanter follows is to make market decisions, not financial decisions. In other works, get in or out depending on signals you see in the market, not because you need to pay the rent.

Kanter emphasizes his firm engages in traditional arbitrage between two similar markets, such as two different stock indexes or between stocks and options, not risk arbitrage that recently has come under fire.

However, Kanter says it is sometimes possible to see the clues to a risk arbitrageur's information. For example, out-of-the money calls with abnormally high implied volatility compared to at-the-money calls may signal that a group is interested in that stock.

Although Kanter is a tape reader, he does watch one fundamental influence - interest rates.

"Interest rates and stocks are lined because program trading has turned the stock market into a money market instrument," he says. "If interest rates start up, the price of stock market insurance will go up."

Reprinted from January, Futures 1987 Issue
Copyright 1987 by Oster Communication Inc., 219 Parkade, Cedar Falls, Iowa 50613

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