Stocks & Commodities V. 24:5 (22-26): Does Consecutive Covered Call Writing Beat Buy & Hold? by Gunter Meissner and Sandra Wu
One of the most popular option strategies meets one of the most popular investing methods Ś which will win?
One of the most popular option strategies is covered
call writing. In this strategy, the investor owns the underlying asset, say a stock, and sells a call option on the asset. The investor believes the stock will move sideways during the option period. In this case, the call premium is earned as additional income. In this article we test whether a consecutive covered call writing strategy outperforms the buy & hold strategy.
THE COVERED CALL WRITING STRATEGY
The covered call writing strategy (CCW) consists of two positions: Holding the underlying asset and selling a call on the underlying. Graphically, this can be expressed as in Figure 1, where the underlying asset
is a stock.
The covered call writing strategy outperforms holding the stock if the stock price stays below the strike price plus the call premium, which in this case is 100 + 10 = 110. (For ease of explanation, in Figure 1 we ignored
the interest rate effect of receiving the call premium at option start and paying a potential payoff later at option maturity.) However, a drawback of the CCW strategy is that it misses out on strong price gains.