Reversing the negative skewness of value portfolios with power-log optimization and options, produces smaller drawdowns and higher risk-adjusted returns

Abstract

Investors prefer positively skewed portfolio returns, while value portfolios have substantial negative skewness in their returns. We use a Power-Log utility optimization algorithm and a put, or call option overlay to reverse the negative skewness of the Russell 1,000 Value index return, and produce portfolios with far better risk and return characteristics than the index itself, using historical monthly returns for the index with VIX-based standard deviation for forecasting. All the optimal portfolios containing the call have positively skewed returns, smaller maximum drawdowns except for the very riskiest portfolios, and higher Sortino ratios than the index, and also have better characteristics than those containing the put.