Option-Writing Strategies in a Low-Volatility Framework

Abstract

Covered call buy–write strategies have risk–return profiles that are similar to those of low volatility equity portfolios, and both approaches appear to extract return premium from investors with leverage constraints and a preference for lottery-like bets. We analyzed simulated long-term (1996–2012) returns of buy–write strategies using one-month and three-month call options on the S&P 500 Index, across a range of strike levels, with monthly and quarterly rebalancing. We found that monthly rebalancing of three-month options generated the most favorable results. We also found that the improvement in risk-adjusted performance achieved with buy–write strategies comes from the skewness premium earned for accepting exposure to the tail risk of substantial losses. In addition, we determined that, due to differences in factor loadings, a buy–write strategy would likely serve well to diversify the risks of a low volatility equity portfolio.