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Covered call strategies are often promoted as an income-generation tool for investors seeking steady returns with reduced risk. But how effective are they in practice? In this post, we take a closer look at their real-world performance across different markets.
 

Do Covered Calls Deliver Superior Returns?

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.
 

Findings

-The study evaluates the performance of a covered call strategy relative to the SPY ETF benchmark over the period from July 2009 to April 2023.

-Three covered call variations are analyzed: at-the-money (ATM), two percent out-of-the-money (OTM), and five percent OTM call options.

-The results show no statistically significant difference between the covered call strategies and the benchmark in terms of overall performance.

-Among the tested strategies, the five percent OTM covered call achieved the highest annualized return of 16%, followed by the two percent OTM with 15%, compared to SPY’s 13%.

-The study cautions investors that these figures do not account for taxes, transaction costs, or implementation expenses, which could reduce the strategy’s real-world profitability.

-The analysis distinguishes between two major market periods — the COVID-19 pandemic and the Russia–Ukraine conflict — to evaluate performance consistency.

-The findings suggest that while covered call strategies may offer comparable or slightly better returns in some conditions, their advantage is not statistically robust.

-The thesis excludes mean-variance ratios due to potential biases caused by the negatively skewed return distribution of covered call strategies.

-The results imply that covered call strategies may be better suited for specific market environments rather than as a general outperforming strategy.

Overall, the study highlights the limited evidence supporting the superiority of covered call strategies over a simple buy-and-hold approach for ETFs.

Reference

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

Do Covered Calls Deliver Superior Returns – Emerging Markets

The previous paper discussed the risk-adjusted returns of the covered call strategy in the US market. Reference [2] further studied the profitability of the covered call strategy in international markets.
 

Findings

-The study evaluates the effect of call writing on ETF portfolio returns and risk, focusing on the Indian capital market.

-Results indicate that adding call writing to ETFs generally reduces returns and increases risk compared to holding ETFs alone.

-Exceptions occur for portfolios using deep out-of-the-money (OTM) options—specifically OTM5 and OTM7—which achieved higher returns but also significantly higher risk.

-The OTM5 portfolio showed a 47% gain in rupee terms and 27% as a percentage of investment, though its risk nearly doubled.

-The high volatility of options often leads to sharp losses, with the potential to erase a year’s gains in a single week of negative returns.

-ETFs, while index-based, do not perfectly track their benchmarks, contributing to deviations in portfolio performance.

-The higher return of the OTM5 portfolio is attributed to a 68% success rate, suggesting potential benefits if the strategy is applied consistently over the long term.

-The findings support the idea that covered call strategies can generate income and manage risk if applied using deep OTM options and maintained for extended periods.

-The study aligns with prior research indicating that covered call strategies underperform in bull markets but can reduce risk or outperform in neutral or declining markets.

In brief, in the Indian market, covered calls yield lower returns with higher risks (as measured by portfolio volatility). The exception is when selling far out-of-the-money call options, but even then, the risk-adjusted returns remain lower due to the higher volatility of returns. This result is consistent with the result in the US market.

Reference

[2] Dr. Abhishek Shahu1, Dr. Himanshu Tiwari, Dr. Mahesh Joshi, Dr. Sanjay Kavishwar, An Analysis of the Effectiveness of Index ETFS and Index Derivatives in Covered Call Strategy, Journal of Informatics Education and Research, Vol 4 Issue 3 (2024)
 

Closing Thoughts

Both studies assess covered call strategies and reach broadly consistent conclusions. The U.S. study finds only marginal performance improvements over buy-and-hold, while the emerging market study shows potential for higher returns using deep out-of-the-money options but at increased risk. Overall, covered calls may enhance income under specific market conditions, though their benefits remain limited and context-dependent.

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