Why covered call?

A

adamchubb

I'm looking at covered call strategy, say for a stock index. Advocates for covered call strategy would say that you can generate income by selling a call and provide some cushion on the downside.

But when I compare the total return (including dividends) of, say S&P 500 index and the corresponding buywrite index, the long-term annualized return of S&P 500 is about 7-8%, while that of the buywrite index is about 4-5%. The long-term return of a buywrite strategy actually does not outperform simply buy & hold of the underlying index. Also, if the long-term annualized return of the buywrite index is just 4-5%, the income we can genuinely expect to generate per year should not be more than 4-5%. Many high dividend stocks or high yield bonds actually pay more than that.

Can someone shed some light about why covered call strategy makes sense?
 
it in itself is not better or worse, as it is nothing more than a naked short put (ignore capital intensity). Those that claim it is a superior strategy are big-mouth retail investors that drive taxis in the day. You need to have a volatility/direction view on the underlying to decide whether to short the call or not. hence it makes sense or not is dependent on your view being good or shit
 
I buy SPY 70% ITM app. 60 day Calls, sell them at 30% profit. Wait for pullback, repeat. Works ok so far and has outperformed my SPY shares. But heck, it is easy when the market goes up. Just need downside protection, which I am still exploring - ideas welcome! Cheers
 
adamchubb said:
I'm looking at covered call strategy, say for a stock index. Advocates for covered call strategy would say that you can generate income by selling a call and provide some cushion on the downside.

But when I compare the total return (including dividends) of, say S&P 500 index and the corresponding buywrite index, the long-term annualized return of S&P 500 is about 7-8%, while that of the buywrite index is about 4-5%. The long-term return of a buywrite strategy actually does not outperform simply buy & hold of the underlying index. Also, if the long-term annualized return of the buywrite index is just 4-5%, the income we can genuinely expect to generate per year should not be more than 4-5%. Many high dividend stocks or high yield bonds actually pay more than that.

Can someone shed some light about why covered call strategy makes sense?
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Your # are wrong on CBOE buy-write index:

http://indexwealthmanagement.ca/BXMIbbotsonStudy.pdf.

It also has a better Sharpe than SPY.

However, if you include commissions and slippages, your return will be worse and your Sharpe will also be worse. How much worse depends on your assumptions on commissions and slippage and how often you update the buy-write. It is not difficult to run a backtest and determine at what commission rate/slippage you will have a lower Sharpe than SPY.
 
ironchef said:
Your # are wrong on CBOE buy-write index:

http://indexwealthmanagement.ca/BXMIbbotsonStudy.pdf.

It also has a better Sharpe than SPY.

However, if you include commissions and slippages, your return will be worse and your Sharpe will also be worse. How much worse depends on your assumptions on commissions and slippage and how often you update the buy-write. It is not difficult to run a backtest and determine at what commission rate/slippage you will have a lower Sharpe than SPY.
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The study was done in 2004, which is more than 15 years ago. How about performance after 2005? I talk about annualized return, not Sharpe ratio.

Below is the annualized return of SPX and BXM
1988-2004 SPX: 12.4%, BXM: 12.7%
2005-2019(Apr) SPX: 8.7%, BXM: 5.3%
 
adamchubb said:
I'm looking at covered call strategy, say for a stock index. Advocates for covered call strategy would say that you can generate income by selling a call and provide some cushion on the downside.

But when I compare the total return (including dividends) of, say S&P 500 index and the corresponding buywrite index, the long-term annualized return of S&P 500 is about 7-8%, while that of the buywrite index is about 4-5%. The long-term return of a buywrite strategy actually does not outperform simply buy & hold of the underlying index. Also, if the long-term annualized return of the buywrite index is just 4-5%, the income we can genuinely expect to generate per year should not be more than 4-5%. Many high dividend stocks or high yield bonds actually pay more than that.

Can someone shed some light about why covered call strategy makes sense?
More...

Covered call under-perform in bull market. It makes logical sense, since you effectively less net long which reduces performance. Allure of covered call is some what smoother return (less draw down, lower volatility). What doesn't make sense?
 
adamchubb said:
The study was done in 2004, which is more than 15 years ago. How about performance after 2005? I talk about annualized return, not Sharpe ratio.
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Sharpe ratio is important for investors. If they want achieve similar volatility as SPX, they can always lever up BXM
 
I have two portfolio one BXM and another SPX total return. SPX outperformed BXM in its entire history by 1.5%, but did so with more than 40% volatility (9.94% vs 14.2%).

Snap1.png


If investor desires similar volatility, all that investor needs to is lever up BXM. I did lever up BXM around 40% to achieve similar volatility as SPX total return. Here are the results.

BXM slightly outperforms SPX total return. But in reality with expenses probably it will be similar to SPX total return. All in all no free lunch with covered call other than smoother curve for non levered version, which means something to investors.

Snap2.png
 
adamchubb said:
The long-term return of a buywrite strategy actually does not outperform simply buy & hold of the underlying index.
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Pardon? That seems incongruous..

How is it that receiving option premium income can reduce the net return over merely holding the index? Is the premium income less than the commission cost to place the option trade? Is there some sort of other fee or benefit excluded??
 
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