Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
Massive Stock Market Price Reversion May Be Days or Weeks Away - 22nd Sep 19
How Russia Seized Control of the Uranium Market - 22nd Sep 19
Dow Stock Market Trend Forecast Update - 21st Sep 19
Is Stock Market Price Revaluation Event About To Happen? - 21st Sep 19
Gold Leads, Will the Rest Follow? - 21st Sep 19
Are Cowboys Really Dreaming of... Electric Trucks? - 21st Sep 19
Gold among Negative-Yielding Bonds - 20th Sep 19
Panicky Fed Flooding Overnight Markets with Cash - 20th Sep 19
Uber Stock Price Will Crash on November 6 - 20th Sep 19
Semiconductor Stocks Sector Market & Economic Leader - 20th Sep 19
Learning Artificial Intelligence - What is a Neural Network? - 20th Sep 19
Precious Metals Setting Up Another Momentum Base/Bottom - 20th Sep 19
Small Marketing Budget? No Problem! - 20th Sep 19
The Many Forex Trading Opportunities the Fed Day Has Dealt Us - 19th Sep 19
Fed Cuts Interest Rates and Gold Drops. Again - 19th Sep 19
Silver Still Cheap Relative to Gold, Trend Forecast Update Video - 19th Sep 19
Baby Boomers Are the Worst Investors in the World - 19th Sep 19
Your $1,229 FREE Tticket to Elliott Market Analysis & Trading Set-ups - 19th Sep 19
Is The Stock Market Other Shoe About To Drop With Fed News? - 19th Sep 19
Bitcoin Price 2019 Trend Current State - 18th Sep 19
No More Realtors… These Start-ups Will Buy Your House in Less than 20 Days - 18th Sep 19
Gold Bugs And Manipulation Theorists Unite – Another “Manipulation” Indictment - 18th Sep 19
Central Bankers' Desperate Grab for Power - 18th Sep 19
Oil Shock! Will War Drums, Inflation Fears Ignite Gold and Silver Markets? - 18th Sep 19
Importance Of Internal Rate Of Return For A Business - 18th Sep 19
Gold Bull Market Ultimate Upside Target - 17th Sep 19
Gold Spikes on the Saudi Oil Attacks: Can It Last? - 17th Sep 19
Stock Market VIX To Begin A New Uptrend and What it Means - 17th Sep 19
Philippines, China and US: Joint Exploration Vs Rearmament and Nuclear Weapons - 17th Sep 19
What Are The Real Upside Targets For Crude Oil Price Post Drone Attack? - 17th Sep 19
Curse of Technology Weapons - 17th Sep 19
Media Hypes Recession Whilst Trump Proposes a Tax on Savings - 17th Sep 19
Understanding Ways To Stretch Your Investments Further - 17th Sep 19
Trading Natural Gas As The Season Changes - 16th Sep 19
Cameco Crash, Uranium Sector Won’t Catch a break - 16th Sep 19
These Indicators Point to an Early 2020 Economic Downturn - 16th Sep 19
Gold When Global Insanity Prevails - 16th Sep 19
Stock Market Looking Toppy - 16th Sep 19
Is the Stocks Bull Market Nearing an End? - 16th Sep 19
US Stock Market Indexes Continue to Rally Within A Defined Range - 16th Sep 19
What If Gold Is NOT In A New Bull Market? - 16th Sep 19
A History Lesson For Pundits Who Don’t Believe Stocks Are Overvalued - 16th Sep 19
The Disconnect Between Millennials and Real Estate - 16th Sep 19
Tech Giants Will Crash in the Next Stock Market Downturn - 15th Sep 19
Will Draghi’s Swan Song Revive the Eurozone? And Gold? - 15th Sep 19
The Race to Depreciate Fiat Currencies Is Accelerating - 15th Sep 19
Can Crypto casino beat Hybrid casino - 15th Sep 19
British Pound GBP vs Brexit Chaos Timeline - 14th Sep 19
Recession 2020 Forecast : The New Risks & New Profits Of A Grand Experiment - 14th Sep 19
War Gaming the US-China Trade War - 14th Sep 19
Buying a Budgie, Parakeet for the First Time from a Pet Shop - Jollyes UK - 14th Sep 19
Crude Oil Price Setting Up For A Downside Price Rotation - 13th Sep 19
A “Looming” Recession Is a Gold Golden Opportunity - 13th Sep 19
Is 2019 Similar to 2007? What Does It Mean For Gold? - 13th Sep 19
How Did the Philippines Establish Itself as a World Leader in Call Centre Outsourcing? - 13th Sep 19
UK General Election Forecast 2019 - Betting Market Odds - 13th Sep 19
Energy Sector Reaches Key Low Point – Start Looking For The Next Move - 13th Sep 19
Weakening Shale Productivity "VERY Bullish" For Oil Prices - 13th Sep 19
Stock Market Dow to 38,000 by 2022 - 13th Sep 19 - readtheticker
Gold under NIRP? | Negative Interest Rates vs Bullion - 12th Sep 19
Land Rover Discovery Sport Brake Pads and Discs's Replace, Dealer Check and Cost - 12th Sep 19
Stock Market Crash Black Swan Event Set Up Sept 12th? - 12th Sep 19
Increased Pension Liabilities During the Coming Stock Market Crash - 12th Sep 19
Gold at Support: the Upcoming Move - 12th Sep 19
Precious Metals, US Dollar, Stocks – How It All Relates – Part II - 12th Sep 19

Market Oracle FREE Newsletter

Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Outperform the Stock Market with Covered Call Options

Companies / Options & Warrants Mar 28, 2012 - 02:21 AM GMT

By: Jim_Fink

Companies Best Financial Markets Analysis ArticleToday’s rock-bottom interest rates and overpriced financial assets have created a low-return investment world that requires proactive yield-enhancement techniques such as covered calls, to generate the additional investment rate of return needed to retire comfortably.

Selling covered calls generates additional income and lowers the break-even cost basis of stock you already own, thus reducing the downside risk of stock ownership at all price points.


Unfortunately, many investors are under the mistaken impression that this strategy underperforms in bull markets. In an article for Personal Finance, an investment advisory service from Investing Daily, I debunked that myth by providing a real-life example involving Chevron Corp (NYSE: CVX). I demonstrated how you could have sold periodic covered calls on Chevron—a stock that appreciated 28.7 percent over a two-year period—and still would have outperformed a simple buy-and-hold strategy.

Many investors think of covered calls as defensive because they provide an income cushion, which is true, but they’re also a bullish strategy that often outperforms just owning the shares.

A new study by Asset Consulting Group (ACG), covering the period between June 1988 and December 2011, underscores the superiority of covered calls over a simple buy-and-hold strategy.

ACG’s study compares the S&P 500’s return with the return of two S&P 500 buy/write indexes: the CBOE S&P 500 BuyWrite Index (BXM), which sells S&P 500 covered calls every month at strike prices “at the money” (i.e., the same price as the underlying index); and the CBOE S&P 500 2% OTM BuyWrite Index (BXY), which sells covered calls every month at strikes 2 percent above the price of the underlying index.

For example, if the S&P 500 were trading at 1,000, the BXM would sell call options with the strike price of 1,000 and the BXY would sell call options with the strike price of 1,020. The contrast in performance was dramatic (see “Covered Calls Outperform over the Long Term: Return and Risk”).

Both S&P 500 buy/write indexes beat the S&P 500 index while incurring less volatility—the best of both worlds. Consider that the S&P 500 rose 360 percent during this 23.5-year period, from 273.50 at the end of June 1988 to 1257.60 by the end of December 2011, and yet a covered-call strategy that generated monthly income in exchange for capping monthly gains still outperformed a long-only S&P 500 portfolio.

That’s a powerful testament to the importance of an income-based investment strategy that reduces portfolio volatility by lessening potential losses in exchange for lessening potential gains. Losses are more damaging to a portfolio’s wealth accumulation than gains of an equal percentage are beneficial, so reducing risk through income generation should be a paramount consideration for any serious investor.

Selling covered calls reduces portfolio volatility and, consequently, improves annualized returns. It’s that simple. What’s amazing is that the covered call strategy’s outperformance is so consistent over different time periods.

Consider the table, “Covered Calls Outperform Over All Time Frames.” Whether you look at periods as short as one year or longer periods up to 20 years, the result is the same: At least one of the covered call indexes outperformed the S&P 500. Moreover, in all time periods except the past three years, both covered-call indexes outperformed.

The bull market that has been in effect since the March 2009 low has been one of the most powerful bull runs of the past century, so we can forgive the at-the-money covered-call strategy for not outperforming during this unique period.

To be fair, covered calls typically generate a greater frequency of taxable gains and losses than a long-only strategy, so it is clearly preferable to sell covered calls on stocks held in a tax-deferred retirement account (see On the Money).

Not only does the sale of covered calls create frequent taxable gains, but there’s also always the risk of early exercise, which would require you to sell the underlying stock. Selling stocks that have very low cost bases because they were bought a long time ago and have since appreciated in value can be especially problematic because their sale could trigger substantial capital gains taxes.

Powerful Options

Nonetheless, the potential benefits of covered calls far outweigh the tax implications. First, if you rely on the income from dividend-paying stocks to pay living expenses, getting your stock called away by the exercise of a covered call is only a minor inconvenience—you can always buy the stock back immediately after exercise to continue receiving dividends.

Second, there is a misconception that the moment a stock rises above the strike price of a covered call, the call will be exercised. This is completely untrue. The value of a call option has two components: (1) Intrinsic value, which is the value you could get right now by exercising the option; and (2) Time value, which is a speculative surcharge based on what the option could be worth if the stock moves higher between now and the option’s expiration date.

Although time value decays and reaches zero at the expiration date, it is greater than zero prior to the expiration date, so an option holder is almost always better off selling a call option—thus receiving both intrinsic value and time value—rather than exercising it and receiving only intrinsic value. Early exercise of a call option is only likely in two scenarios. By recognizing these two scenarios and taking action to eliminate them (i.e., buying back the call and selling a different one), you can reduce the risk of option exercise. The two scenarios are:

(1)    The covered call option is deep “in the money”—which means that the underlying stock trades far above the call strike—and the bid price of the call option is below the “intrinsic value” one could get from exercising the call. For example, if a stock trades at $77 and a $70 call option is bid $6.75/$7.25, the call owner would make more money exercising and receiving $7 ($77-$70) than he would selling the call for $6.75.

(2) The covered-call option is “at the money” or “in the money” when an ex-dividend date is near.

In the ex-dividend scenario, a call owner will exercise early if the amount of the dividend exceeds the amount of time value he will forfeit by exercising the call.

For example, if XYZ stock trades at $50 and the $45 call sells for $5.20, the call has $5.00 of intrinsic value ($50-$45) and $0.20 of time value. If an ex-dividend date is tomorrow and the dividend is $0.50 per share, the call owner will exercise early because the $0.50 dividend is greater than the $0.20 of time value forfeited.

However, if the dividend were only $0.10 per share, the call owner wouldn’t exercise because the call option’s time value would be worth more than the dividend amount. (See “Early Exercise is Unlikely.”)



Remember, writing covered calls is not a sell-and-forget strategy, but one that requires monitoring. Given the impressive outperformance covered calls have generated over time, however, the small degree of monitoring that is required is well worth it. For a more detailed guide on options trading, check out my free Options Trading Strategies guide

© 2011 Copyright Jim Fink - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules