Do Covered Calls Deliver Superior Returns?

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The covered call strategy is a popular and conservative options trading approach. It involves an investor holding a long position in an underlying asset, typically a stock, and then selling call options on that asset. These call options provide the buyer with the right to purchase the underlying asset at a predetermined strike price within a specific timeframe. By selling these calls, the investor generates additional income through the premiums received.

While the covered call strategy provides an additional income, it caps potential profits if the asset’s price rises significantly. Covered calls are often employed by investors seeking income while holding a moderately bullish view of the underlying asset’s price. It can be an effective way to enhance returns and manage risk in a portfolio.

The investment management industry has actively promoted the covered call strategy. But in reality, does it deliver superior returns compared to the buy-and-hold approach? Reference [1] effectively examined this question. The author pointed out,

This thesis analyses the performance of the covered call strategy and compares it to a benchmark ETF SPY in terms of annualized returns and annualized standard deviation. The analysis is conducted on a period from 17.7.2009 until 21.4.2023. During the period, annualized returns and standard deviation are calculated for covered call strategy constructed using ATM, two percent OTM, and five percent OTM call options…

Results suggest no statistically significant difference between the performance of any of the covered call strategies examined in the thesis compared to the benchmark (SPY). In terms of annualized returns, the best performance was achieved by the CC constructed using five percent OTM call options followed by the two percent OTM call options. Both of the approaches managed to outperform the benchmark, having an annualized return of 16% and 15%, respectively, while the benchmark achieved only a 13% return during the examined period. However, we note that the investor should remain cautious when selecting the CC strategy. Based on these results, it may seem attractive to use this strategy, however, one should also pay attention to the fact that the calculation does not include tax implications, transaction fees and higher costs to enter the strategy, which could hinder the returns of the CC and make it less favourable.

In summary, the article concluded that covered calls do not statistically yield superior returns when compared to buy and hold.

This article adds to the growing body of research that raises questions about the performance of covered calls. However, we have reservations about the validity of the research regarding the 2% and 5% out-of-the-money (OTM) covered calls. It appears that the author calculated the 2% and 5% OTM option prices using at-the-money (ATM) implied volatility. Why didn’t the author employ the readily available market prices of these options instead?

Let us know what you think in the comments below or in the discussion forum.

References

[1] Tomáš Ježo, Effect of covered calls on portfolio performance, 2023, Charles University

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