Deciphering the World of Covered Call Closed-End Funds

A recent article in the WSJ titled “Buy-Write: Safe Harbor in Troubled Times?” by Brett Arends discussed the benefits of covered-call strategies. We believe there are many attractive characteristics to the strategy, and owning it in a closed-end format seems to make even more sense than other structures. Additionally, covered-call closed end funds are currently trading at deeply discounted levels. Below are some reasons we like the strategy pulled from the article. Also, we included a spreadsheet which describes the differences of the between the numerous covered-call closed-end funds (Covered Call Closed-End Cheatsheet).

1. Call options are usually overpriced. Those who sell them tend to make more money than those who buy.
2. The strategy "has generated superior risk-adjusted returns over the last 18 years… generating a return comparable to that of the S&P 500 at approximately two-thirds of the risk."
3. From 1988 through 2006, Callan said the buy-write strategy had made compound returns of 11.77% a year compared to 11.67% for the S&P, with much less volatility.
4. Over the past two years, someone who invested in a regular S&P 500 index fund would be down 43%. At the lows, early last month, they were down 54%.Over the same period, someone following the BXM would have lost a much more modest 25%. At the worst point they were down 37%.
5. Over a ten year period, buy-and-hold investors in the total US stock market have lost about 2% of their money. Investors pursuing a BXM strategy would be up about 13%.
6. From April 1989 to the present, the BXM has made total returns of about 400% -- slightly ahead of the broad US equity market. In other words, the buy-write index beat the stock market, with a lot less volatility.

While there is common mention of covered-call funds in this article and many others, authors fail to mention the differences between the funds, and how their strategies differ.We thought this would help.

Disclosure: The Author does not have any positions in the funds mentioned.

Comments

[F. Bradeen:]

One huge caveat with these covered call closed end funds to watch out for and that is their claimed interest rates are mostly return of capital. Check that out before you buy any of these.

May 15 01:02 PM

[klarsolo:]

Selling covered calls is a good strategy, but it's difficult to find a good fund. One fund doing that (and several other, UNDISCLOSED option strategies), HCE, blew up last October and lost over 80 % of its value. It got liquidated just a few weeks ago.

But of course there are some good ones out there, for example NFJ, currently trading at an attractive discount. The buyer just really has to do his homework first. I'd also avoid levered funds as much as possible.

May 15 04:49 PM

[Dean M:]

I would be interested to know what type of macro environment would be less favorable to these vs a regular index fund?

May 16 07:29 AM

[sid.v.:]

True - you need to be aware how much "interest" is really attributed to return of capital; however, unlike receiving interest, return of capital is not a taxable event (if used in a taxable account)


On May 15 01:02 PM F. Bradeen wrote:

> One huge caveat with these covered call closed end funds to watch
> out for and that is their claimed interest rates are mostly return
> of capital. Check that out before you buy any of these.

May 16 06:36 PM

[Fred Thomson:]

Another option is to sell calls on the stocks one already owns. Check out . Anyone who does this will need some sort of tool to help him make decisions on when to manipulate his positions. A great tool can be downloaded at coveredcallcalculator.net

May 17 12:48 PM