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The Data Around Selling Covered Calls | Skinny on Options Data Science

Jan 22, 2016

By: Michael Rechenthin, Ph.D.

What Call Should I Sell?

A common question that we get on the tastytrade Research Team is, “I want to sell a covered call. What strike should I choose?” Remember, selling (or writing) a covered call is a strategy that sells a call against shares of stock you own. You would do this to reduce the cost basis of the long stock, which in turn increases the probability of profit. Typically, you sell one call for every 100 shares. 

To answer this question, we looked at two different covered call strategies: (1) selling an at-the-money (ATM) call versus (2) selling an out-of-the-money (OTM) call at 30-delta. We also compared the covered calls to simply buying and holding the S&P 500. You can get all the details from the “Skinny on Options Data Science” segment from January 14.

Before I get to the answer, here’s a quick comparison of the different strategies based on the price of the S&P 500 ETF (SPY) on January 20 (closing price $185):

coveredcalls_data

Selling the ATM call receives the largest amount of premium, but the maximum profit is capped at the premium received ($5 per share in this example) – but this also means that the breakeven is $185-$5 = $180. The 30-delta call, on the other hand, receives a smaller premium but the upside is larger – $8 per share. The downside is less since the premium received is smaller – $185-$3 = $182. 

For a quick analysis, we can compare BXM, the CBOE’s S&P 500 at-the-money covered call index, and BXMD, the CBOE’s S&P 500 30-delta covered call index, with the S&P 500 total return index (which is inclusive of dividends).

covered calls_data

While the 30-delta covered call had the best performance since 2000, the at-the-money covered call did pretty well over time, too, compared to buy and hold.

Next, we took a look at the relative performance in bull markets.

Covered Calls_Bull Market

Finally, we look at the performance during bear markets.

CoveredCalls_BearMarket

The bottom line is selling either at-the-money or 30-delta covered calls in the S&P 500 outperforms simple buy and hold in most scenarios. But there is no “best” strike since it depends on your outlook of the stock. The 30-delta call provides a higher potential return while the ATM call provides for a lower breakeven. It’s the strategy that matters most.  Getting probability and positive time decay from the short call on your side happens when you sell an at-the-money or out-of-the-money call against long stock. 

For more information on this strategy, watch the Skinny on Options Data Science episode here called “The Data Around Selling Covered Calls”. 

If you have any questions about the segment, leave a comment below or feel free to reach out to research@tastytrade.com.

 

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