Investors may change their equity risk premium exposure by buying or selling the index, or change their volatility risk premium exposure by buying or selling straddles.
We suggest that investors ignore the storytelling about obtaining downside buffers and generating income. This strategy may only generate income to the extent that any other strategy generates income, by buying or selling mispriced securities or securities with an embedded risk premium. Avoid the temptation of overly focusing on payoff diagrams. If you believe the index will rise and implied volatilities are rich, the covered call is a step in the right direction of expressing that view.
If you have no view on implied volatility, there is no reason to sell options. Selling volatility is generally and correctly considered a risky strategy.
In this paper, we attempt to demonstrate that many of the myths surrounding covered call strategies are in fact just that: In our view the myths collectively conceal the simple fact that option overwriting is a version of selling volatility. It may be a good stand-alone strategy when implied volatilities are high relative to expectations and, in particular, a good strategy when combined with earning the equity risk premium.
The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. Past performance is not a guarantee of future results. Login Enter your email address and password to sign in.
One Fact and Eight Myths. Add to Reading List. Roni Israelov, Lars Nielsen Topic: A copy of this paper is available to AQR clients directly from our online database.
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