While the S&P 500 would be expected to outperform buy-write strategies in an aggressively rising market, when the markets are trading sideways or selling off, the BXM has an opportunity to outperform the S&P 500.
The premium generated by writing covered calls can create additional cash flow when markets are flat, as well as provide a buffer against downside movement in a falling market.
The strategy is a viable choice for investors looking to generate income on their portfolio of equities, while also reducing volatility and padding downside market exposure.
Covered Call Premium
The premium generated from writing covered calls not only reduces portfolio volatility and losses in a falling market but can also generate meaningful income especially when coupled with a portfolio holding dividend paying stocks.
A significant portion of the yield generated from covered calls stems from the historical tendency for Implied Volatility (as measured by the VIX) to exceed realized volatility.
This is a good thing for the seller of the option, who is being compensated for selling volatility and thus receives more than they would have if Implied Volatility was lower.
Covered Call Strategy
When used correctly, covered calls can play four key roles in a portfolio.
• They can generate additional cash flow on equity holdings when markets are trading flat, down or calmly up.