The “Superior Performance” of Covered Calls on the S&P 500: Rethinking an Anomaly

Abstract

This study shows that previous findings of the superior performance of covered calls on the S&P 500 are spurious because they ignore or dismiss skewness. While academics have previously identified this problem, the financial industry has largely ignored it. The authors show how the problem manifests in that traditional performance measures used in other studies show superior performance even with correctly priced options. They present two new estimates of covered call alphas—one that embeds a benchmark and the other that subtracts the benchmark—and find little basis for these prior claims. The authors also identify a bias in previous studies in which the chosen holding period disguises the effect of skewness. Their results, which are supported in both monthly and daily data, are consistent with intuition that holding the index and selling these widely traded options cannot generate alpha, as has been highly promoted in several practitioner articles.

TOPICS: Options, performance measurement, exchange-traded funds and applications

Key Findings

• • The documented abnormal performance of covered call writing is largely driven by disregard of skewness.

• • There are simple measures that can adjust the alpha of an option strategy for skewness.

• • The positioning of the holding period during the expiration month can disguise the problem.