Covered Calls May Be Conducive For This Market Climate

Bob Carey
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Covered Calls May Be Conducive For This Market Climate

Posted Under: Broader Stock Market

View from the Observation Deck

From 2000-2013, the CBOE S&P 500 BuyWrite Index (an index designed to measure a covered call strategy) outperformed the S&P 500 in six of the 14 calendar years.
While covered call options can generate an attractive level of current income, they also can cap the potential for capital appreciation.
The use of covered calls tends to be most beneficial to investors when the stock market posts down years (2000, 2001, 2002 & 2008) and when returns range from 0% to 12% (2004, 2005, 2007 & 2011).
From 1926-2013, the S&P 500 posted an average annual total return of 10.08%, according to Ibbotson & Associates/Morningstar. That average sits near the upper end of the 0% to 12% range.
Covered call writing tends to be less beneficial when stock market returns are well above their normal range, such as in 2013, when the S&P 500 posted a total return of 32.39% (see chart).
Today, the S&P 500 stands about 5.0% below its all-time high of 1848.38 set on 1/15/14. At current levels, we believe that corporate earnings growth will have the greatest influence on the direction of stock prices.
The 2014 estimated earnings per share growth for the S&P 500 was 9.61% on 2/4/14, according to Bloomberg. That target fits nicely into the 0% to 12% range.

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 is a capitalization-weighted index comprised of 500 stocks 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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Posted on Tuesday, February 4, 2014 @ 4:08 PM • Post Link

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These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

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