Warren Buffett versus Zvi Bodie: Should You Buy Or Sell Put Options?

Abstract

Academics and investment professionals often disagree when it comes to investment advice. Legendary investor Warren Buffett is a proponent of time diversification and firmly believes that stocks are less risky in the long run. Therefore, he often sells long-term put options instead of buying them for portfolio protection. By contrast, famous professor Zvi Bodie argues that time diversification is a fallacy and, therefore, his advice to fund managers is to buy long-term portfolio insurance. In this paper, we consider the optimal portfolio choice problem for a loss-averse investor. First, we demonstrate that our loss-averse investor subscribes to the principle of time diversification. In particular, our investor allocates more to stocks as the investment horizon lengthens. Second, we allow our investor to trade in stocks and put options. We find that when the investment horizon is short, our investor is better off with portfolio insurance. Conversely, when the investment horizon is long, our investor sells put options. That is, our loss-averse investor prefers Buffett’s investment advice over Bodie’s.

TOPICS: Portfolio theory, portfolio construction, risk management, derivatives, options

Key Findings

• ▪ Legendary investor Warren Buffett is a proponent of time diversification, and, therefore, he often sells long-term put options instead of buying them for portfolio protection.

• ▪ Famous professor Zvi Bodie argues that time diversification is a fallacy and his advice to fund managers is to buy long-term portfolio insurance.

• ▪ In this article, we show that a loss-averse investor prefers Buffett’s investment advice over Bodie’s.