View from the Observation Deck

Covered call strategies tend to be most beneficial when the stock market posts negative returns, or when returns range from 0%-10%.

The S&P 500 Index posted negative total returns just three times in the table above. The CBOE BuyWrite Index outperformed the S&P 500 Index in two of those three years (missing the hat trick 3/3 by 0.39 percentage points in 2018). For comparison, there are four years in the table where the S&P 500 Index posted returns between 0% and 10%. During those time periods, the CBOE BuyWrite Index outperformed the S&P 500 Index in three of the four years (missing the fourth year by 0.66 percentage points in 2005). The S&P 500 Index surged by 26.26% in 2023, outperforming the CBOE BuyWrite Index by 14.44 percentage points. For comparison, the S&P 500 Index lagged the CBOE BuyWrite Index by 6.76 percentage points when markets were negative in 2022.

Covered call options can generate an attractive income stream and serve as a hedge against negative price movement, but they may limit the potential for capital appreciation.

There were 13 years in today’s table where the S&P 500 Index posted total returns of 10% or more. The CBOE BuyWrite Index underperformed the S&P 500 in every one of them.

Takeaway: Covered call strategies offer a unique alternative to the S&P 500 Index. The income they provide has generally led to outperformance during negative or moderately positive periods. This income comes at a potential cost, however, as returns can be capped during periods where the market is performing exceedingly well. As the table shows, the CBOE BuyWrite Index outperformed the S&P 500 Index in five of the seven periods where the S&P 500 Index posted annualized total returns of 10% or less. For comparison, the CBOE BuyWrite Index underperformed the S&P 500 Index in all 13 of the years where the S&P 500 Index posted returns of more than 10%. Recent forecasts indicate that equity strategists expect a relatively flat market in 2024. On December 19, 2023, a Bloomberg survey of 19 such strategists revealed that their average 2024 year-end price target for the S&P 500 Index was 4,833. On January 10, 2024, the S&P 500 Index closed at 4,783.45. 

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The CBOE S&P 500 BuyWrite Index (BXM) is designed to track a hypothetical buy-write strategy on the S&P 500. It is a passive total return index based on (1) buying an S&P 500 stock index portfolio, and (2) "writing" (or selling) the near-term S&P 500 Index (SPXSM) "covered" call option.

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