Rob Carrick reported that so far cover-call ETF results have been disappointing. Some investors have been surprised by this, but the real surprise is that so many seemed to expect outperformance.
At its core, a covered-call strategy involves owning stocks and selling call options on those stocks. Compared to a strategy of just owning stocks, the difference is obviously the short position in call options. So, for a covered-call strategy to outperform, the excess profits would have to come from the options.
For the options to be profitable, traders would have to consistently trade call options far above their real value. Why would anyone expect this to be the case for such short-term financial instruments?
Even if writing covered calls has no expectation of excess profits, it is reasonable to expect that it will change the volatility of investment returns. But again, I see no reason to expect that we will be left with anything other than the usual relationship between risk and reward: the higher the risk, the greater the expected reward.
Investors who like a covered-call strategy because of the way it changes the volatility characteristics of returns may be making a sensible choice for their situation. But this is very different from expecting outperformance.
Carrick is quite right that “We’ll need a full cycle of stock market ups and downs to properly judge covered call ETFs.” My expectation is that a full stock market cycle will see the covered-call strategy underperform by the costs involved in implementing the strategy. If covered calls prove to be profitable, it would expose a surprising inefficiency in markets.