Covered calls are something that intuitively sound good. Also, they're one of the few things about options that my father taught me, and parents always know best (unless you're a teenager
).
But they may not work well as long term investments. If you write covered calls that never get exercised, they boost returns (let's say, 1%/year) while not reducing volatility. That's because if you shift your entire performance line up by 1% it's still got the same jiggles, just 1% higher.
Actual volatility is reduced by lopping off peaks when the market jumps and the calls are exercised. That's the exact opposite of the way you want to reduce volatility. Think Sortino ratio, that measures downside volatility only.
And those lost returns from lopping off peaks? They cost a lot more than the relatively small income stream one gets from writing the calls. Here's a graph from Finominal showing how this strategy loses in a rising market. And markets tend to rise over the long term.
Writing calls does generate a certain income stream, which many investors look for. Though as the writer of the article accompanying the graph says:
Any investor can create income by simply selling a small stake of their portfolio, which is also favorable from a taxation perspective as capital gains tend to have lower tax rates than income.
https://caia.org/blog/2024/02/24/covered-call-strategies-uncoveredThat's a sentiment I agree with and why I focus more on total return than divs with bond funds. YMMV.
Comments
"In years where stocks declined, eg the global financial crisis in 2008 or the bear market in 2022, the call options expired worthless but did provide investors with additional income that reduced the drawdowns*."
*(YBB Note) By tiny amounts. Basically, covered calls didn't provide downside protection unless some puts were bought using the covered call income.
AMD
SMCI
NVDA
AAPL
TSLA
ARM
MSFT
AVGO
And retails stocks TGT WMT CAVA
SPY IWM qqqq also
Delta 7-10% wklies cover calls contracts are usually free $
Prem usually [+ ~0.25% ]
Aapl move extremely slow you can do maybe little higher deltas like 12 13%..most folks I know do delta 14 15% w
I have seen so many of these "special" funds fail again and again.
Remember, the price is the ultimate indicator = KISS and total returns is what matters because it includes everything.
If you are OK disclosing, what function do these funds serve within your portfolio?
Why do you own the covered call strategy on QQQ in a CEF? In your experience, what portion (in a range) of the portfolio does the manager write the calls on?
My questions are out of curiosity.
Why a CEF? I've owned QQQX for several years, and frankly, option overlays in an ETF wrapper weren't widely available at the time. There may be better options available currently, but this works for me and I'm comfortable with its longer track record and balance between distributions/asset growth.
As for portfolio coverage, Nuveen states: "During the quarter, the core
option overwrite level varied between 41% and 66% of the equity portfolio's value with an average level of 56%". Their option strategy is discussed in the attached link, which I found interesting.
https://documents.nuveen.com/Documents/Nuveen/Default.aspx?uniqueId=378e5e6a-448d-49f8-b723-f56fc1f5876c
But my concerns are the investors who have poor/no knowledge of options but are buying options-based funds thinking that they are all-weather income funds.
Call-writing (-selling or -shorting) funds are a bull market phenomenon. They turn capital gains (CGs) into options income, but don't protect the downside. They have grown like weeds in this bull market due to lots of marketing hype.
Moreover, the traditional application of call-writing uses boring but steadily growing (mature?) stocks that don't move around much. So, investors holding those boring stocks can write calls and boost income some with the call premiums. Call-writing on volatile things like QQQ, on the other hand, is nontraditional and counts on rising markets that trigger written calls again and again to transform possible LT-CGs into ST options income. You may want to hold these in tax-deferred/free accounts.
It isn't as if JPM has found some secret sauce for JEPI (AUM $34.8 billion, inception May 2020) and JEPQ (AUM $15.7 billion, inception May 2022). Granddaddy of options-based fund is GATEX / GTEYX that has been around since December 1977 (soon after options started trading in the US) and in those 46+ years, it has gathered an AUM of $6.6 billion. FWIW, it never impressed me much. Gateway is now a neglected part of French Natixis that also owns some more visible boutiques - Oakmark/Harris, Loomis Sayles.
Natixis https://www.im.natixis.com/en-us/home
Exactly. I've mentioned risk profiles in a few other posts. There's been little response but that doesn't mean that everyone is familiar with them. Here's the risk profile of a covered call and and the risk profile of a pure long position overlayed. These are two of the simplest risk profiles you can have.
This shows a current stock price of about 39 and a strike price of 40. You do get about $1 worth of "insurance" if the stock price falls. But that's little consolation if the price drops $3 (left side of the graph). And you get a little extra profit in the middle if the stock doesn't rise past the strike price.
But all the profit you might have gotten with larger price gains (right side of graph) is lopped off. That's a big price to pay for a cash stream if you're not carefully curating your call writing as Yogi described.
Anything other than a pure long position alters (distorts?) the risk profile and makes metrics like standard deviation suspect. In part simply because you're no longer dealing with a normal distribution of outcomes and in part because the risk may be all bunched into low probability (but very bad) events that aren't reflected in the aggregate numbers (haven't happened recently).
I took a quick look at DIVO. Nice fund, because the manager carefully selects and watches over the securities for which he writes calls. At the end of the day this (like all trading, I suppose) constitutes a form of timing. Quoting Yogi again, there's no "secret sauce".
Since the selloff in March 2020, DIVO has run neck and neck with solid straight equity income funds: passive, like VYM and NOBL; and active like VEIRX.
Portfolio Visualizer comparison
This is not to put down DIVO. It has done remarkably well and looks to be a fund well worth considering. And it significantly outperformed in March 2020 (despite offering just "small" insurance).