Journal of Investment Strategies

Risk.net

Smaller drawdowns, higher average and risk-adjusted returns for equity portfolios, using options and power-log optimization based on a behavioral model of investor preferences

Jivendra K. Kale and Tee Lim

  • Power-log utility optimization algorithm based on a behavioral model of investor preferences.
  • Optimal portfolios contain the S&P 500 index, a Treasury, and either a call or a put index option overlay.
  • All optimal portfolios have positively skewed returns, which are preferred by investors, in contrast to the negative skewness of S&P 500 index returns.
  • All optimal portfolios have higher risk-adjusted returns than the S&P 500 index.
  • Except for extremely conservative optimal portfolios, all optimal portfolios containing the call option also have higher expected returns than the S&P 500 index, and optimal portfolios containing the put option.

We use a power-log utility optimization algorithm based on a behavioral model of investor preferences, along with either a call or a put option overlay, to reverse the negative skewness of monthly Standard & Poor’s 500 (S&P 500) index returns and to produce portfolios with smaller drawdowns and far higher risk-adjusted returns than the S&P 500 index. All the optimal portfolios have positively skewed returns, which are preferred by investors. Optimal portfolios containing the call have higher average returns than the S&P 500 index as well as much higher average and risk-adjusted returns than portfolios containing the put, except for the most conservative portfolios.

To continue reading...

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here: