So-called “covered call” or “buy write” investment strategies have been a popular method used by investors to enhance the income returns from owning shares. This note sets out some empirical evidence on the historic success of such a strategy over US equities and, specifically, a strategy similar to the one underpinning the BetaShares S&P 500 Yield Maximiser Fund (managed fund) (ASX Code: UMAX).
Buy write or covered call strategies
As detailed in an earlier blog post, a “covered call” or “buy write” strategy involves selling call options against an investor’s share portfolio to gain extra income. By selling a call, investors earn income in exchange for giving up the right to some upside share price appreciation, if the share prices rise beyond a certain level (these are called ‘premiums’).
As should be apparent, such an options strategy is most likely to perform well when share prices are at best rising only modestly, or are trending sideways or down. The strategy will likely detract from performance in periods when share prices are rising strongly.
Various studies have explored the evidence over whether buy write strategies are able to outperform the market. One problem with these studies, however, is that – especially over shorter time periods – the results are sensitive to market conditions. As noted above, for example, “buy write” strategies are likely to under perform during strong bull market periods, with potential to outperform in weaker market conditions.
The chart below presents the long-term evidence on the S&P 500’s BXY Index, maintained by the Chicago Board Options Exchange (CBOE). This index tracks a strategy of holding the S&P 500 index and also selling monthly call options against the index which are 2% out of the money (OTM) – i.e their strike prices are 2% above the S&P 500’s current index level. The results are instructive in highlighting the effectiveness of a buy-write strategy over US equities, particularly due to the extensive track record of the BXY index. In addition, the strategy employed by the BXY index is similar (but not identical) to the strategy employed by BetaShares S&P 500 Yield Maximiser Fund (managed fund) (ASX Code: UMAX). Please note however that the strategy employed by UMAX differs from the BXY strategy in that it uses the volatility of the underlying security as an input for selecting the OTM strike (i.e. rather than strictly 2%).
As seen in the chart below, the BXY strategy has tended to outperform the market during periods when the market was trending sideways to down, though under perform when the market was rising strongly. Indeed, the strategy has generally underperformed in recent years due to the strong United States bull market.
That said, what’s noteworthy is that the broad trend of relative performance has been upward – and over the entire period studied, the BXY strategy ended up with positive relative performance as compared to the S&P 500 Index – in other words, over market cycles, the buy-write strategy outperformed the underlying index. Indeed, as was the case at the market bottoms in both March 2003 and March 2009 out performance by the BXY Index during the previous two strong bear market periods more than made up for the years of under performance during stronger bull market periods.
What’s more, even if we concede the BXY index has only tracked market performance over this period – the table below show it has done so with less volatility in returns. In particular, the regular receipt of option premium income helped cushion downside volatility.