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Income Lab Ideas: Exploring Option-Strategy Performance Drag



  • Generally, an option strategy works best when the market is trending sideways or slightly down.
  • In a market that generally trends in an upward manner, an option strategy will have a 'drag' on performance.
  • We are looking to quantify this drag so we can better understand what to expect from our funds that utilize an option strategy.
  • This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Get started today »

Co-produced by Stanford Chemist

The path to successful investing is starting out with understanding what you are owning in the first place. Of course, diversification can help in this respect as well! Today, we are going to be looking at several funds that utilize option strategies. These are all funds that utilize covered call writing on either individual stock holdings within their portfolio or on indexes to help generate premium. The more advanced CEF investors may already know that an options strategy tends to actually have a drag on performance over time. For those that are newer to CEFs, this may be surprising to find out! This is exactly what we are looking to quantify in today's piece, which is how much of a 'drag' an options strategy can have overall on a fund.

When I reference a 'drag' on performance, all I am referring to is the fact that the strategy will generally lag the underlying index. Why is that with options? Well, simply put, the market has an upward trend in general. This means the funds utilizing these strategies, especially in the case of index options, are having to purchase back the options contract at a higher price than the premium they received to close out the position. Additionally, on index options, there is a theoretical infinite loss potential as an index could go to infinite. Of course, this won't happen, but the higher the index goes the higher the loss potential. This is offset by the underlying holdings in the portfolio that would also likely be rising in tandem with the upward movements of such an index.

So far this sounds like an option fund doesn't have a place in a portfolio since they are losing money through this strategy. Of course, that isn't true either. Option funds do have

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This article was written by

Nick Ackerman profile picture
Nick Ackerman is an avid student of the markets and has been investing in his own accounts for over 14 years. He is a former Financial Advisor and has previously qualified for holding Series 7 and Series 66 licenses. These licenses also specifically qualified him for the role of Registered Investment Adviser (RIA), i.e., he was registered as a fiduciary and could manage assets for a fee and give advice. Since then he has continued with his passion for investing through writing for Seeking Alpha, providing his knowledge, opinions, and insights of the investing world. His specific focus is on closed-end funds as an attractive way to achieve income as well as general financial planning strategies towards achieving one’s long term financial goals.


I provide my work regularly to CEF/ETF Income Laboratory with articles that have an exclusivity period, this is noted in such articles. CEF/ETF Income Laboratory is a Marketplace Service provided by Stanford Chemist, right here on Seeking Alpha.

Analyst’s Disclosure: I am/we are long BDJ, BOE, ETW, IGA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

This article was originally released to members of the CEF/ETF Income Laboratory on February 1st, 2020.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (14)

gastro4 profile picture
As always enjoy your articles.
I own a number of option income CEFs and consider them a defensive portion of my equity portfolio.
I like the tax free ROC, that these funds turn STCG into LTCG (if I sell), the monthly compounding effect and if I leave these funds to my heirs they get a stepped up tax basis (hoping law doesn’t change).
Nick Ackerman profile picture
Thank you and I'm glad you enjoyed! And that definitely is one benefit if the stepped up basis law doesn't change!
"Generally, an option strategy works best when the market is trending sideways or slightly down."

"In a market that generally trends in an upward manner, an option strategy will have a 'drag' on performance."

The above is generally true for an index fund. I have been selling cash secure puts on just a single underlying, when the underlying goes upward, I have the opportunity to buy back the option and reuse the same cash for future trades. That said, for CEF using an index cover call strategy, during black swan events, I agree, its a great way to preserve NAV.
Nick Ackerman profile picture
Thank you for reading and adding your input!
Goggin profile picture
What do the comparisons show if distributions are all reinvested?
Nick Ackerman profile picture
Thank you for the question. I'm not sure as this wasn't really a look at comparing these funds on a total return basis.
sc21 profile picture
nick- Thanks your piece which I actually have to reread to be sure I follow it all. I think that you have to at least separate options funds into two different sets. One is strategic funds that hold mostly stocks in a single sector. This can include both stk and bst and then the second set which has a wider range of holdings. Your present piece covers the issue well for general covered call funds. The key for focused funds is to compare how they do overtime to other specialized funds in the say sector. In that respect the focused funds tend to offer higher payouts but their total returns should be lower. Lower by the way does not mean bad merely lower. Some who buy stk may think that they are buying a tech fund. In fact they are biuying a covered call fund in a tech wrapper. This has to be the case in an up market as their best stocks get called way as they sell calls. Both styles have advantages as long as you know what you are getting so to speak. thanks again. sc
Nick Ackerman profile picture
Thank you for your feedback! Yes, it can be difficult to follow with so many numbers being presented. I wanted to get a feel for the "general covered call funds" and how they can perform during various periods. This may allow for some insights into how they could possibly perform in future environments.
sc21 profile picture
Nick yes but you need to understand what you are getting. Not all option funds are alike .That was my point. best sc
NV_GARY profile picture
The use of the ROC in a taxable account reminds me that it would be good to know what funds pay high or all qualified distributions (preferably).
Nick Ackerman profile picture
That's an excellent topic that may be worth exploring! Thank you, @NV_GARY!
I like your articles. My BME sank last week but shouldn't have however today got back about even. I just take the dividends from it anyway. Healthcare stock make a ton but you can't get paid unless you sell! The options come in handy. I bought more BCX in the unloved commodity sect to reduce my costs. They should cover dividends on income alone but I expect more bounces.

BOE is an interesting stock. Full of staples and medical but it doesn't seem to suit and options strategy well since these stocks don't move much. CII would seem to perform better with tech stocks that can have broad swings. I think the Blackrock CEFs can really help for income. Leverage is great in a long bull, but now not so much.

I appreciate your coverage of CEFs. Most people want quick killer trades. CEFs are for the patient!
Nick Ackerman profile picture
Thank you, @jasonjones! I also hold BME and agree with your sentiment on the fund. I am a fan of the BlackRock funds in general, they have always treated me well!
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