The markets being closed today, provided a good opportunity to pull together performance for the Index Covered Call Portfolio. (ICC). A summary of the activities performed to achieving these results is included at the bottom of this post and the conceptual trading plan for this portfolio is shown here .
As shown below from initiation of the approach on Feb. 24, 2013 to Dec. 31, 2013 the covered call portfolio outperformed the underlying index! At the same time the results are also less volatile. Better results with less volatility means a better risk-adjusted rate of return.
Description SPY SPY- CC IWM IWM-CC
Cap Gain Return 4.1% 4.1% 1.9% 1.9%
Dividend Return 2.3% 2.3% 2.0% 2.0%
Option Return 0% 1.3% 0% 2.4%
TOTAL RETURN 6.4% 7.7% 3.9% 6.4%
Monthly Std. Dev. 2.9% 2.0% 3.6% 1.9%
Worst Month -6.0% -4.1% -6.6% -2.1%
Please note that all results are unaudited. Additionally, past performance is no guarantee of future results. That is certainly true for these results as different returns and volatility in the underlying indexes will generate different results. However, the case study does seem to support most of the premises for using covered calls such as
- An investor using covered calls must remember that writing the covered call is just the first step and would be well served to have a plan/system to manage those calls. This portfolio suggests one approach that seemed to work in this case.
- Performance for covered calls as compared to just holding the underlying index will likely be
- better in flat and down markets
- worse in up markets
- Covered calls do dampen volatility. To the degree that is positive characteristic of a lower risk portfolio this strategy can be beneficial to an overall portfolio.
* * * * * * * Summary of Approach * * * * * * *
The stock market had moved up handsomely in the first months of 2012. At that time, I decided to to select and follow an approach to managing covered calls. This article describes the actual results of writing monthly covered calls against the S&P 500 ETF (SPY) and the Russell 2000 ETF (IWM) for the last ten months of 2012. The following describes the process used and corresponding results.
- On February 24, 2012 the SPY was purchased at $136.75.
- At the same time, a call expiring the next month (March) with a strike of $139 was sold against the position. The strike price was chosen because it has a delta value of around 33. This article will not attempt to describe option pricing theory and the the greeks. Suffice it to say this delta level was chose because it seemed to strike a good balance between
- the probability of expiring above that price (about 33%) and having to deal with the potential calling away of the stock vs.- obtaining a material premium for the sale of the call
- The option was held until
- That option's delta went below 10 or over 90 or
- 3 days prior to expiration.
- When those conditions were met, the option was rolled to
- the next expiration date with greater than 15 days until expiration. (usually the next month)
- with a delta once again near 33.
- Using these guidelines the process was redone every month. It triggered twelve rolls of the option over the next ten months. Not surprisingly,
- four of those option rolls were done at a loss because the stock had moved well passed the strike price of the option
- and eight were done for modest gains.
That ratio of 4 of 12 times is what would have been expected with option having a delta of 33%
- On February 24, 2012 the IWM was purchased at $82.74. The March $85 call was sold at the same time. For the rest of the year the same process described above of rolling the option when the delta on that option got to 10 or 90 was followed.
- This situation also triggered twelve rolls of the option over the next ten months. Those twelve option rolls generated a net credit of $201.45 or 2.43%.
- This return was in addition to the 1.91% capital appreciation of the etf and 2.04% in dividends paid. Overall that means the returns for
- Buy and Hold IWM was 3.95%
- Buy and Hold with covered calls was 6.38%.
In this case the covered calls turned a very modest return into something much better.
- Additionally, just as shown above, the covered call portfolio was also less volatile
- The monthly standard deviation of covered calls was just 1.7% vs 3.3 % if just holding the ETF. Almost half the volatility.
- The maximum monthly draw down of the covered call portfolio was just 2.1% vs 6.6% for simply holding the ETF.