Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
CATHY WOOD ARK GARBAGE ARK Funds Heading for 90% STOCK CRASH! - 22nd Jan 22
Gold Is the Belle of the Ball. Will Its Dance Turn Bearish? - 22nd Jan 22
Best Neighborhoods to Buy Real Estate in San Diego - 22nd Jan 22
Stock Market January PANIC AI Tech Stocks Buying Opp - Trend Forecast 2022 - 21st Jan 21
How to Get Rich in the MetaVerse - 20th Jan 21
Should you Buy Payment Disruptor Stocks in 2022? - 20th Jan 21
2022 the Year of Smart devices, Electric Vehicles, and AI Startups - 20th Jan 21
Oil Markets More Animated by Geopolitics, Supply, and Demand - 20th Jan 21
WARNING - AI STOCK MARKET CRASH / BEAR SWITCH TRIGGERED! - 19th Jan 22
Fake It Till You Make It: Will Silver’s Motto Work on Gold? - 19th Jan 22
Crude Oil Smashing Stocks - 19th Jan 22
US Stagflation: The Global Risk of 2022 - 19th Jan 22
Stock Market Trend Forecast Early 2022 - Tech Growth Value Stocks Rotation - 18th Jan 22
Stock Market Sentiment Speaks: Are We Setting Up For A 'Mini-Crash'? - 18th Jan 22
Mobile Sports Betting is on a rise: Here’s why - 18th Jan 22
Exponential AI Stocks Mega-trend - 17th Jan 22
THE NEXT BITCOIN - 17th Jan 22
Gold Price Predictions for 2022 - 17th Jan 22
How Do Debt Relief Services Work To Reduce The Amount You Owe? - 17th Jan 22
RIVIAN IPO Illustrates We are in the Mother of all Stock Market Bubbles - 16th Jan 22
All Market Eyes on Copper - 16th Jan 22
The US Dollar Had a Slip-Up, but Gold Turned a Blind Eye to It - 16th Jan 22
A Stock Market Top for the Ages - 16th Jan 22
FREETRADE - Stock Investing Platform, the Good, Bad and Ugly Review, Free Shares, Cancelled Orders - 15th Jan 22
WD 14tb My Book External Drive Unboxing, Testing and Benchmark Performance Amazon Buy Review - 15th Jan 22
Toyland Ferris Wheel Birthday Fun at Gulliver's Rother Valley UK Theme Park 2022 - 15th Jan 22
What You Should Know About a TailoredPay High Risk Merchant Account - 15th Jan 22
Best Metaverse Tech Stocks Investing for 2022 and Beyond - 14th Jan 22
Gold Price Lagging Inflation - 14th Jan 22
Get Your Startup Idea Up And Running With These 7 Tips - 14th Jan 22
What Happens When Your Flight Gets Cancelled in the UK? - 14th Jan 22
How to Profit from 2022’s Biggest Trend Reversal - 11th Jan 22
Stock Market Sentiment Speaks: Are We Ready To Drop To 4400SPX? - 11th Jan 22
What's the Role of an Affiliate Marketer? - 11th Jan 22
Essential Things To Know Before You Set Up A Limited Liability Company - 11th Jan 22
NVIDIA THE KING OF THE METAVERSE! - 10th Jan 22
Fiscal and Monetary Cliffs Have Arrived - 10th Jan 22
The Meteoric Rise of Investing in Trading Cards - 10th Jan 22
IBM The REAL Quantum Metaverse STOCK! - 9th Jan 22
WARNING Failing NVME2 M2 SSD Drives Can Prevent Systems From Booting - Corsair MP600 - 9th Jan 22
The Fed’s inflated cake and a ‘quant’ of history - 9th Jan 22
NVME M2 SSD FAILURE WARNING Signs - Corsair MP600 1tb Drive - 9th Jan 22
Meadowhall Sheffield Christmas Lights 2021 Shopping - Before the Switch on - 9th Jan 22
How Does Insurance Work In Europe? Find Out Here - 9th Jan 22
MATTERPORT (MTTR) - DIGITIZING THE REAL WORLD - METAVERSE INVESTING 2022 - 7th Jan 22
Effect of Deflation On The Gold Price - 7th Jan 22
Stock Market 2022 Requires Different Strategies For Traders/Investors - 7th Jan 22
Old Man Winter Will Stimulate Natural Gas and Heating Oil Demand - 7th Jan 22
Is The Lazy Stock Market Bull Strategy Worth Considering? - 7th Jan 22
METAVERSE - NEW LIFE FOR SONY AGEING GAMING GIANT? - 6th Jan 2022
What Elliott Waves Show for Asia Pacific Stock and Financial Markets 2022 - 6th Jan 2022
Why You Should Register Your Company - 6th Jan 2022
4 Ways to Invest in Silver for 2022 - 6th Jan 2022
UNITY (U) - Metaverse Stock Analysis Investing for 2022 and Beyond - 5th Jan 2022
Stock Market Staving Off Risk-Off - 5th Jan 2022
Gold and Silver Still Hungover After New Year’s Eve - 5th Jan 2022
S&P 500 In an Uncharted Territory, But Is Sky the Limit? - 5th Jan 2022

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

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