Abstract

The aim of this paper is to structure and optimize a dynamic put spread strategy to build an enhancement and protection portfolio. To implement the investment strategy a short put option acting as enhancement and a long put option providing protection are combined: the resulting put spread is modeled, thus assuming a dynamic configuration, depending on market conditions. The investment parameters and objectives are then translated into a proper optimization algorithm. The optimization procedure is implemented and backtested on S&P500 Index as the underlying asset, and it shows that the algorithm actually results in an optimal configuration of the final put spread. The backtest additionally exhibits that the optimized strategy provides an overall over-performance with respect to the underlying asset. The paper presents a novel approach when implementing put spread strategy to enhance and protect portfolio by explicitly modeling the implied volatility and volatility skew, and dynamically adjusting the portfolio depending on market conditions.

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