In order to know what to expect from a covered call strategy, it is helpful to review some of the academic literature on the topic. Here I am going to summarize findings presented in a paper published by the Asset Consulting Group in January of 2012. A study by Ibbotson Associates dating back to 2004 and a Callahan study from 2006 are also worth reading. All of these studies are available on the CBOE web site.
The ACG study compares the performance of four CBOE indices with the performance of the S&P 500 index. The four indices are:
BXM, which sells monthly at-the-money covered calls against S&P 500 stocks.
BXY, which sells monthly 2% out-of-the-money covered calls against S&P 500 stocks.
PUT, which holds U.S. Treasury bills and sells monthly at-the-money put options.
CLL, which sells monthly 10% out-of-the-money covered calls against S&P 500 stocks as well as buying 5% out-of-the-money puts every three months.
The following graph shows how selling puts as well as covered calls has been a superior strategy to outright stock ownership. All strategies had higher returns as well as lower volatility over the time period. The CLL strategy (known as a collar) has much lower returns and I personally do not consider it an appealing strategy. It is also interesting to see that selling naked puts has outperformed selling covered calls by a significant margin, even though the two strategies are almost identical in theory.
A covered call strategy is likely to underperform a long only portfolio in a bull market and outperform in a bear market. However, while outperforming, it can still perform quite poorly in a rapidly declining market.
It is striking that the BXY and PUT indices outperformed the S&P 500 in 2009, a very strong year for stocks. Such are the benefits of selling covered options when premiums are very high. Conversely, 2008 showed how exposed a covered call strategy is to a market crash, even if the results are not quite as bad as holding stocks outright.
Selling puts or covered calls is not for the very bullish (who should be outright long) or the very bearish (who should stay away from stocks). As I am neither in the current environment, the strategy suits me well.