The CBOE website (www.cboe.com) references three major studies that have been performed over the past 10 years on the risk-return dynamics of covered calls. All three firms concluded that a passive buy-write strategy has a better risk-return profile than long-only equities. Specifically, the covered call index (symbol BXM) has earned roughly the same annualized return as the S&P 500 over the long term but at significantly lower risk (30-33% lower average standard deviation). Today’s macro environment, with historically low yields and elevated risks, is particularly well suited for covered call strategies, as these strategies typically offer a lower risk allocation for equity portfolios and a and a potentially high yield alternative for fixed income allocations.
In practice, the full spectrum of covered call strategies is very broad (see above graphic). The first category consists of managers who seek to replicate the BXM index. The second category does not deviate from holdings of the S&P 500 (no stock selection process) but seek to outperform the index through options management. This category is often referred to as “semi-replication.”
The third (and largest) category incorporates stock selection and seeks to outperform the index through two sources of alpha (stock selection and options management). The further to the right a strategy lies, the more relative risk it is taking (and the more the results may deviate) relative to the index. Strategies on the far right are often either levered or seek alpha through higher beta holdings and volatility capture.
The Van Hulzen Covered Call strategy is positioned on the far left of the active covered call category. The universe of holdings consists mainly of S&P 500 stocks, but uses stricter parameters in order to screen out the weakest components and own only the highest quality names in the index. The option contracts are positioned dynamic in terms of duration and strike price. The result is a portfolio that is equally balanced between fundamental value potential and potential income generation.
Historically, the strategy has had 65% of market risk and with an equity portfolio beta around 0.9 and a further volatility reduction coming from the option positions.