Using a covered call overwriting strategy to generate income
Geoff Kirk, co-manager of the Premier Miton Global Sustainable Optimum Income Fund, discusses the recent boom in popularity of option selling strategies.
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Familiar options
Previously little-known financial contracts called options have hardly been out of the news in recent years. From the meme stock craze fuelled by retail investors buying call options with pandemic stimulus cheques, to the current trend in 0DTE options (options traded on the day that they expire), there has been huge growth in the volumes of equity options traded.
This increased investor familiarity with options goes beyond these headline grabbing phenomena. We have also seen a substantial increase in the assets of professionally managed funds that employ strategies selling options:
Assets under management (US Dollars) of funds in the Morningstar ‘Derivative Income’ category
Source: Morningstar data from 31.01.2013 to 31.10.23.
There are multiple strategies that can be classed as ‘options-selling’, but the simplest and longest standing is the strategy of covered call overwriting (or buy-write as they call it in the US). As an example of the recent surge, the $28bn JPMorgan Equity Premium Income ETF, that employs covered call overwriting, is now the world’s largest actively managed ETF having taken in $10bn so far this year.
Covered call overwriting involves selling call options over shares that you own. This has the effect of setting a cap on the upside you can achieve on that share over a short period in exchange for an upfront cash payment. It is therefore a more defensive strategy that will underperform when share prices rise strongly but has the potential to outperform in other market environments.
Reassessing their objectives
The post global financial crisis era, framed with low interest rates and strong government stimulus, where many assets appreciated in value may be no more, inflation and the subsequent interest rate rises have put an end to that. So, clients are re-assessing their objectives and how best to achieve them. Expectations that future equity returns may be more uncertain than usual, due to the prevailing geopolitical and economic landscapes, may be making investors more comfortable with reduced upside exposure.
Covered call overwriting funds also appeal to those with the specific objective of generating income. The fee that funds receive for selling the options is distributed in the funds’ dividend, this can then be used to support lifestyles in the face of a cost-of-living crisis.
The Premier Miton Optimum Income fund and the Premier Miton Global Sustainable Optimum Income fund have yield targets of 7% and 6% respectively which is above even the now elevated rates available on cash deposits. Our method of covered call overwriting reduces your exposure to share price upside but doesn’t eradicate it, we still leave plenty of room for potential capital growth alongside the income. So, for those able to invest in equities we think they may make a compelling proposition in the current environment.
Reminder of the Premier Miton Optimum Income Fund objective:
- The objective of the Premier Miton Optimum Income Fund is to provide a yield of 7% per annum together with the prospect of capital growth over the long-term, being five years or more. Five years is also the minimum recommended period for holding shares in this Fund.
- This does not mean that the Fund will achieve the objective over this, or any other, specific time period and there is a risk of loss to the original capital invested.
- The Fund’s target yield is not guaranteed and may change if the assumptions on which the target is calculated change.
- Income will be paid four times a year as dividend distributions.
Reminder of the Premier Miton Global Sustainable Optimum Income Fund objective:
- The objective of the Fund is to provide a yield of 6% per annum together with the prospect of capital growth over the long term, being five years or more. Five years is also the minimum recommended period for holding shares in this Fund.
- This does not mean that the Fund will achieve the objective over this, or any other, specific time period and there is a risk of loss to the original capital invested.
- The Fund’s target yield of 6% per annum is not guaranteed and may change if the assumptions on which the target is calculated change.
- Income will be paid four times a year as dividend distributions
