Covered Call Strategies Uncovered
Trading income for capital returns
July 2023. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- Covered call strategies aim to offer index-like returns with lower volatility and higher yields
- They have underperformed their benchmarks significantly over longer periods
- They are tools for market timing, but that is difficult to execute successfully
INTRODUCTION
JP Morgan has been a late-comer to the ETF industry, but achieved remarkable success in the actively-managed ETF space as it manages the two largest products, namely the JPMorgan Equity Premium Income ETF (JEPI) with $26 billion and JPMorgan Ultra-Short Income ETF (JPST) with $24 billion of assets under management.
Intuitively, investors might have expected growth or value-focused products from well-known active managers like Fidelity or PIMCO to dominate, but instead, JEPI represents a covered call strategy.
JEPI represents a portfolio of large-cap stocks that is combined with selling call options to generate monthly income. The objective, like for all covered call strategies, is to offer index-like returns with lower volatility but higher dividends. In this research article, we will explore if covered call products have been able to meet these goals.
UNIVERSE
We consider all funds trading in the US that pursue covered call strategies, which is a universe of 28 mutual funds and ETFs. The combined assets under management are $52 billion, although JEPI dominates with its $26 billion. Annual management fees are 0.78% on average, but range from 0.35% to 1.20%.
Most investors use covered call strategies when they believe stock markets will be trading sideways in the short to medium-term, where the upside is limited but the total portfolio return can be enhanced by selling call options. Given this, the average yield of a covered call fund is 6.4%, compared to a mere 1.6% for the S&P 500 (read Resist the Siren Call of High Dividend Yields).
