What is the latest evidence on attractiveness of selling covered calls or buying protective puts on the U.S. stock market? In his February 2021 paper entitled “Revisiting Covered Calls and Protective Puts: A Tale of Two Strategies”, Bryan Foltice examines raw and risk-adjusted returns from systematically selling covered calls and buying protective puts on SPDR S&P 500 ETF Trust (SPY) as a proxy for the stock market. Specifically, at the beginning of each month, he sells fully hedged calls or buys fully hedged puts on SPY with one month to expiration. He estimates option prices via the Black-Scholes option pricing model, using the CBOE VIX Index for SPY volatility and accounting for dividends. He considers a range of option moneyness, ranging from 5% out-of-the-money (OTM) to 5% in-the-money (ITM) in 1% increments. Using monthly SPY price, VIX level and risk-free rate during March 1993 through September 2020, he finds that:
- Covered call strategies ranging from 5% OTM to 2% ITM beat SPY buy-and-hold by up to an average 0.49% per month on a gross basis, with lower monthly volatility.
- Monthly gross Sharpe ratios range from 0.27 for 5% ITM to 0.37 for both 1% OTM and at-the-money (ATM), compared to 0.15 for SPY buy-and-hold.
- Frequencies of monthly gross losses range from 7% for 5% ITM to 31% for both 4% OTM and 5% OTM, compared to 37% for SPY buy-and-hold.
- Monthly gross 1-factor (market) alphas range from 0.04% for 5% ITM to 0.59% for both 2% OTM and 3% OTM. Betas range from 0.18 for 5% ITM to 0.89 for 5% OTM.
- Results are consistent in the first and second halves of the sample period.
- Protective put strategies significantly underperform SPY buy-and-hold on a gross basis and increase the frequency of monthly losses (up to 75% for 3% ITM). Other performance metrics confirm underperformance.
- OTM (ITM) covered call strategies offer the highest utility for investors with less than (greater than) average loss aversion.
In summary, covered calls on SPY are attractive on a gross basis across a range of moneyness, but protective puts are not.
Cautions regarding findings include:
- The study employs modeled rather than actual option prices. Findings therefore depend on the accuracy of the pricing model.
- All results are gross, not net. Accounting for SPY option trading frictions (which vary by moneyness) would materially reduce all returns, such that net findings may differ substantially from gross findings. See “Are Equity Index Covered Call ETFs Working?” for performance of exchange-traded funds (ETF) that implement covered call strategies. The author reports that he plans to revise the paper with estimated frictions.
See also “Covered Equity Index Calls Worldwide” and “Do Protective Equity Index Puts Work Well?”.
