Derivatives can be effective when you know what you’re buying or selling.
Covered call option strategies can be an innovative and potentially impactful way to mitigate investment risk and generate income—arguably an important component of many goals-based financial plans that pursue those goals.
However, not all covered call strategies work the same way—a fact that can often go unnoticed and may result in surprising outcomes for advisors and their clients.
Case in point: Check out the recent returns of two indices that track different covered call investment methodologies (see the chart).
- The CBOE S&P BuyWrite index—a popular benchmark in the derivative income space that writes a one-month, at-the-money call option covering 100% of the portfolio—has increased 13% over the past 12 months.
- However, the CBOE S&P 500 Half BuyWrite Index—which covers only 50% of the value of the portfolio—has gained 22.7% over that period.
- The performance gap between the two indices: 9.7 percentage points.
1-Year Return of a 100% Covered Call Index and 50% Covered Call Index
Source: Bloomberg, calculations by Horizon Investments, as of March 22, 2024
Past performance is not indicative of future results. Indices are unmanaged and do not have fees or expense charges, both of which would lower returns. It is not possible to invest directly in an unmanaged index.
The upshot: The details matter when using derivatives like call options to construct goals-based portfolios.
Since many leveraged, index-tracking ETFs use various types of derivative strategies, it may be a good idea to understand how a particular approach to calls and other derivatives is structured—and what that could mean (or not mean) for its potential performance. In this case, it’s balancing an income goal with market participation, which can be an important tradeoff with goals-based plans.
Horizon is dedicated to assisting advisors who may want to help their clients pursue goals-based results.
For more news, information, and analysis, visit the ETF Strategist Channel.
Options are not suitable for all investors and carry additional risks. Options used in a strategy to reduce volatility and generate returns may not perform as intended and could expose the strategy to losses, e.g., option premiums, to which it would not have otherwise been exposed.
This commentary is written by Horizon Investments’ asset management team. Past performance is not indicative of future results. Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any security. This report does not attempt to examine all the facts and circumstances that may be relevant to any company, industry, or security mentioned herein. We are not soliciting any action based on this document. It is for the general information of clients of Horizon Investments, LLC (“Horizon”). This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any analysis, advice, or recommendation in this document, clients should consider whether the security in question is suitable for their particular circumstances and, if necessary, seek professional advice. Investors may realize losses on any investments. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. All investing involves the risk of loss.
The CBOE S&P 500 BuyWrite Index is a benchmark index designed to show the hypothetical performance of a portfolio that engages in a buy-write strategy using S&P 500 index call options. The CBOE S&P 500 Half BuyWrite Index (BXMH) is a benchmark index designed to track the performance of a hypothetical covered call strategy. You cannot invest directly in an index. References to indices, or other measures of relative market performance over a specified period of time are provided for informational purposes only. Reference to an index does not imply that any account will achieve returns, volatility or other results similar to that index. The composition of an index may not reflect the manner in which a portfolio is constructed in relation to expected or achieved returns, portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility or tracking error targets, all of which are subject to change. Indices are unmanaged and do not have fees or expense charges, both of which would lower returns. It is not possible to invest directly in an unmanaged index. The investments recommended by Horizon Investments are not guaranteed. There can be economic times when all investments are unfavorable and depreciate in value. Clients may lose money. This commentary is based on public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The opinions expressed herein are our opinions as of the date of this document. These opinions may not be reflected in all of our strategies. We do not intend to and will not endeavor to update the information discussed in this document. No part of this document may be (i) copied, photocopied, or duplicated in any form by any means or (ii) redistributed without Horizon’s prior written consent. Forward-looking statements cannot be guaranteed. Other disclosure information is available at www.horizoninvestments.com.
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