Several studies have been undertaken to determine the effectiveness of the covered call writing strategy. I believe that it is important to evaluate the parameters that are used as well as how they are employed in these evaluations to assess the accuracy of the findings. In 2002, BXM was developed by the CBOE (Chicago Board Options Exchange) in cooperation with Standard & Poor’s. This is a benchmark index that tracks the performance of a hypothetical covered call strategy on the S&P 500 index. Data on this index can be accessed as far back as 1986. The parameters for this index are as follows:
- Buy an S&P 500 index portfolio
- Sell 1-month slightly out-of-the-money calls (SPX) options
- Hold until expiration Friday and then cash-settled
- Then a new 1-month, slightly out-of-the-money call is sold
Two major studies performed on the BXM concluded that BXM returns similar compound annual percentage returns as the S&P 500 index but with much less volatility:
BXM study by Callan and Associates
This was an 18-year study that determined that BXM returned annual percentages of 11.77% compared to the S&P 500 returns of 11.67%. However, BXM did so with a standard deviation (volatility) of 9.29% compared to the 13.89% of the S&P 500, one third less.
BXM study by Ibbotson Associates
This 16-year study concluded that BXM returns 12.30% per year compared to 12.20% of the S&P 500 also with two thirds the volatility.
Advantages of using BXM to traditional covered call writing
- Less time management required
- Less cash required
- Instant diversification
Returns in the long run are quite similar to that of the S&P 500 but in bear markets BXM will outperform. Here is a 5-year chart of BXM compared to the S&P 500 from 2008 through June-2013 which included the recession of 2008:
Although this time frame was an aberration as it included one of the worst recessions in US history, it is clear that BXM (blue) slightly outperformed the S&P 500 (black) for the first 4 years but not so far in 2013. Generally speaking, in the long run, the returns will be similar.
Why the BCI system generates greater returns
- We are not required to hold every stock in the index. We can select the best performers
- We can avoid the risk of earnings reports
- We can utilize different strike prices, not only slightly out-of-the-money strikes
- We can initiate exit strategies, not simply wait for expiration Friday
Most studies undertaken to evaluate the covered call writing strategy do not take advantage of all the opportunities that exist to elevate returns. BXM will mirror the returns of the S&P but with much less volatility. The BCI system will elevate the returns of BXM by implementing fundamental, technical and common sense parameters. Which approach is best for you is something only you can determine. Once educated, the right choice will be an easy one to make.
When Ben Bernanke, the Federal reserve Chairman, announced plans to “moderate the pace” of its bond-buying program, the global markets reacted negatively. He said the program may end in mid-2014. That aside, the economy continues to improve as shown in the latest economic reports:
- The Fed may end its $85 billion a month bond buying program if unemployment drops under 7% next year
- The federal funds rate will remain near zero until unemployment dips below 6.5%
- US consumer prices increased by 0.1% in May as inflation remains under control
- Core CPI (excludes food and energy) rose by 0.2%
- Minutes from the May FOMC meeting reflected a positive overview of the US economy as a result of a strong housing market, and increases in household spending and business investment
- Sales of existing homes rose by 4.2% in May, the fastest pace since the fall of 2009 when the federal tax credit program was available
- The median single-family home price was up 15.8% from a year ago to $208,700, the best increase since October, 2005
- There is a 5.1 month supply of homes on the market better than the 6.5 month figure from a year ago
- New home construction increased by 6.8% in May as housing as a whole was up 29% in May from one year ago
- The Conference Board’s index of leading economic indicators moved up 0.1% in May
For the week, the S&P 500 declined by 2.1%, for a year-to-date return of 13%, including dividends.
In the past month the VIX is up about 42% and the S&P 500 is down about 5%:
IBD: Market in correction
BCI: This site remains bullish on the overall economy but because of the market over-reaction to Chairman Bernanke’s comments will take a defensive posture for the July contracts and use predominantly in-the-money strikes.
Much success to all,