\r\n \r\n Summary\r\n
\r\n \r\n - \r\n Covered call strategies often seek to balance yield generation and price appreciation,\r\n but simple strike selection methods, like targeting a percent-of-spot or yield level, can lead to\r\n risk\r\n inconsistencies.\r\n
\r\n - \r\n A more adaptive approach uses the option \"delta\" to systematically target the desired balance.\r\n
\r\n - \r\n Compared to other methods, the delta-strike selection may adjust better across underlyings and\r\n through different market environments.\r\n
\r\n
\r\n \r\n Introduction\r\n
\r\n \r\n Selling covered calls presents an inherent trade-off between generating yield and retaining potential\r\n for price appreciation. Certain strategies focus on yield, limiting exposure to price appreciation—for\r\n instance, those that sell at-the-money calls. However, when investment managers wish to maintain more\r\n exposure to price appreciation, they often seek a balance between yield and upside.\r\n
\r\n Although this trade-off can appear straightforward, maintaining the right balance between income and price\r\n appreciation can be challenging with covered call strategies, given the variability of option prices across\r\n different underlying securities and over time.\r\n
\r\n Some specialized managers may focus their efforts on predicting target stock prices, either based on\r\n fundamentals or technical indicators. For these managers, strike selection may be highly discretionary.\r\n However, many investors seeking to generate yield from covered calls may benefit from the discipline and\r\n consistency offered by a systematic approach.\r\n
\r\n Implementing a systematic call overwriting strategy aimed at balancing income and price appreciation can\r\n falter if the strike selection approach is overly simplistic, leading to inconsistencies in the risk profile\r\n of the strategy. A method to more consistently achieve the desired balance involves selecting strikes based\r\n on \"delta\".\r\n
\r\n While quantitatively oriented managers often use delta-based strikes, a significant portion of assets\r\n tracking covered call strategies may not incorporate any option models into their decision-making. However,\r\n a quick delta calculation can aid both investment managers and their clients in choosing strikes.\r\n
\r\n \r\n Moving forward, I'll highlight some of the pitfalls of simplistic strategies and contrast them with the\r\n robust solutions presented by the delta-strike selection method.\r\n
\r\n\r\n \r\n Targeting a Percent-of-spot\r\n
\r\n\r\n \r\n Arguably the simplest way to systematically select option strikes is by targeting a percentage of the\r\n underlying price. For example, a strategy might sell 3-month calls 10% out-of-the-money. If the price a\r\n stock was $50 when rolling the strategy, the listed strike closest to $55 might be selected.\r\n
\r\n While this strike percentage might be appropriate in certain market conditions for a stock with certain\r\n volatility, it may not provide sufficient yield for a lower-volatility, higher-dividend stock.\r\n Conversely, for a highly volatile stock, a 10% price appreciation cap may be too low, despite the higher\r\n option premium offered by the market. The following table illustrates the inconsistency across three\r\n different underlying stocks.\r\n
\r\n \r\n
\r\n
\r\n 3-month, 10% out-of-the-money calls\r\n
\r\n
\r\n
\r\n As of 5/19/20231\r\n
\r\n
\r\n In this case, a manager seeking to sell covered calls on BAC might view a target strike 10%\r\n out-of-the-money as achieving a balanced yield-price appreciation trade-off. However, for TSLA, the same\r\n strike could be considered too low due to the stock's volatility. For PEP, the annualized yield at the\r\n nearest listed strike might be too low, making a lower strike call more consistent with the strategy’s\r\n objective.\r\n
\r\n Just as the fixed-percentage-strike might not consistently meet objectives for different underlying\r\n securities on a given day, the same fixed-percentage strike might not pick the best strikes over time for\r\n the same stock. For example, in a market with relatively high volatility, selling 3-month calls on a given\r\n stock 15% out-of-the money may generate the right tradeoff between upside and yield. However, when\r\n volatility and option prices are lower, the sweet spot might be a lower strike.\r\n
\r\n \r\n Targeting a Yield Level\r\n
\r\n\r\n \r\n An alternative to the fixed-percentage strike methodology would be to target a consistent annualized\r\n yield from the premium raised, as a percent of the underlying price, determining the strike that targets\r\n the same yield each month. For example, a strategy that targets 10% annualized premium selling 3-month\r\n calls would select the strike each quarter corresponding to the call option worth 2.5% of the underlying\r\n stock price.\r\n
\r\n \r\n This approach would adjust the strikes of lower volatility stocks to be closer to the money, while\r\n strikes for higher volatility stocks would be further out-of-the-money, such that each stock generates a\r\n similar yield. However, for a diverse set of underlyings, a single yield level could create\r\n inconsistencies in risk profiles.\r\n
\r\n \r\n For instance, if a manager decided to target a 10% annual option premium yield for each stock in the\r\n portfolio, that yield might be too high for some stocks, as achieving such a yield could result in some\r\n calculated strikes being in-the-money. Conversely, for a high-volatility stock, the same yield level may\r\n not provide sufficient compensation for the risk of forgoing a substantial gain, despite the higher cap.\r\n
\r\n\r\n \r\n
\r\n
\r\n 3-month Calls Targeting 10% Annual Premium Yield\r\n
\r\n
\r\n
\r\n As of 5/19/20231\r\n
\r\n
\r\n In this example, targeting 10% annual option premium for BAC might be consistent with an objective to\r\n balance option yield and potential price appreciation. However, a manager seeking such a balance might\r\n want to target a lower yield for PEP and a higher yield for TSLA.\r\n
\r\n\r\n \r\n A More Adaptive Approach with Delta-Strikes\r\n
\r\n\r\n \r\n When considering a more effective and balanced approach, a more refined methodology for selecting strike\r\n prices in covered call strategies involves using the option \"delta.\" The delta of an option provides a\r\n measure of the sensitivity of the option's price to changes in the price of the underlying asset. It can\r\n be interpreted as the expected change in the option's price for a $1 change in the underlying asset's\r\n price.\r\n
\r\n \r\n For a more balanced approach to writing covered calls, the delta of the option can play a pivotal role.\r\n By considering the delta, investment managers can systematically target desired balance in their strike\r\n price selection. Should they want to tilt the strategy to more income, they can select a higher delta.\r\n Conversely, if their intent is to preserve more upside, they can select a lower delta. They can then\r\n apply that delta across the entire portfolio of covered calls systematically, creating a similar balance\r\n between income and upside for each underlying security.\r\n
\r\n \r\n A call option with a 50% delta, typically at-the-money or very near, might be fitting for investment\r\n managers aiming for more income. On the other hand, a call option with a delta of 30%, typically\r\n out-of-the-money, can offer more potential upside, which can be more suitable for investment managers\r\n seeking greater price appreciation.\r\n
\r\n\r\n \r\n The following table illustrates the results of targeting a 30% delta across TSLA, BAC and PEP.\r\n
\r\n\r\n \r\n
\r\n
\r\n 3-month Calls Targeting 30% Delta\r\n
\r\n
\r\n
\r\n As of 5/19/20231\r\n
\r\n
\r\n Compared with the fixed-percentage strike and target-yield approaches, these strikes more consistently\r\n balance yield and upside for each underlying, based on the individual option prices.\r\n
\r\n \r\n Further, as market conditions change, a delta-based strike selection strategy naturally adapts to target\r\n a consistent balance between yield and potential price appreciation. When market volatility increases,\r\n using delta-strike selection will often yield higher premiums (thus more income) and increase the cap on\r\n potential price appreciation, as out-of-the-money options become more expensive. On the other hand, when\r\n market volatility decreases, the same delta-strike strategy will adjust, selecting strikes that offer a\r\n balanced combination of lower yield and lower potential price appreciation.\r\n
\r\n \r\n While selecting a strike based on a constant delta may not always result in the same yield, it may\r\n maintain\r\n a consistent trade-off between yield and price appreciation, both over time and across different\r\n underlying\r\n stocks. The level of yield will generally be proportional to the underlying's volatility, leading to a\r\n higher\r\n yield\r\n when volatility is high and vice versa. This consistency can help in reducing risk and providing more\r\n predictability for the strategy over time.\r\n
\r\n \r\n However, this is not to say that it is a one-size-fits-all solution. Just as with any other strategy,\r\n careful consideration and regular adjustment are required. Investment managers must choose the delta\r\n that\r\n aligns with their strategy's specific objectives and risk tolerance. Regardless, the introduction of\r\n option\r\n pricing models like delta into the decision-making process for strike selection can indeed add value to\r\n a\r\n covered call strategy.\r\n
\r\n\r\n \r\n Historical Illustration of Strike Selection Methods\r\n
\r\n \r\n To illustrate the behavior of different strike selection methods over time, we'll compare the strike\r\n selection methods over time historically. As an example, we will take 3-month calls on Bank of America\r\n Corporation (BAC).\r\n
\r\n The chart below shows the resulting percent-strikes of the selected options over time. As we can\r\n see, the target-yield and delta-strikes fluctuate over time. This is because they adapt\r\n to changing market conditions. Target-yield, focused solely on achieving a consistent yield, adjusts more\r\n dramatically as it seeks to maintain a constant annualized yield from the premium raised.\r\n
\r\n The delta-strike, on the other hand, adjusts more gradually, moving up or down as volatility increases or\r\n decreases. The changes in delta-strike are not as large as those in target-yield because it maintains a\r\n balance between yield and potential price appreciation, rather than being solely focused on yield.\r\n
\r\n \r\n
\r\n
\r\n Evolution of Percent-Strike Over Time\r\n
\r\n
\r\n
\r\n
\r\n Next, let's look at the annualized yield for the 3-month BAC calls. In this case, the percent-strike\r\n strategy's annualized premium\r\n varies significantly as volatility rises and falls. When\r\n volatility is high, the yield can be high as well, but it drops when volatility decreases. As a result,\r\n the\r\n income generated from the percent-strike strategy can be inconsistent, fluctuating with changes in\r\n market\r\n volatility.\r\n
\r\n The delta-strike strategy's yield also varies, albeit in a more controlled manner. This is\r\n because as volatility rises, the delta-strike strategy allows for some increase in upside-cap, as well as\r\n in annualized premium yield. This provides a balance between yield and potential\r\n price appreciation, potentially making it a more adaptive approach to strike selection over time.\r\n
\r\n \r\n
\r\n
\r\n Historical Annualized Yield for 3-Month BAC Calls\r\n
\r\n
\r\n
\r\n
*/}\r\n {/* Although there is no one-size-fits-all approach to strike selection in covered call*/}\r\n {/* strategies, the delta-strike selection method offers a balanced, adaptive, and systematic approach. This*/}\r\n {/* strategy adjusts to market conditions, maintains a balance between yield and potential price*/}\r\n {/* appreciation, and ultimately, brings consistency to the risk profile*/}\r\n {/*
*/}\r\n\r\n {/**/}\r\n {/* In the next section, we will present some illustrative examples to show how delta-strike selection*/}\r\n {/* can*/}\r\n {/* provide a more consistent balance of yield and potential price appreciation. The examples will shed*/}\r\n {/* light on*/}\r\n {/* how delta-based strike selection can adjust with the market conditions to help achieve the intended*/}\r\n {/* balance*/}\r\n {/* in a covered call strategy. Stay tuned.*/}\r\n {/*
*/}\r\n\r\n\r\n \r\n Practical Implications of Delta-Strikes in Portfolio Management\r\n
\r\n\r\n \r\n Having explored the potential benefits of a delta-based strategy for covered call writing, it is useful\r\n to consider the practical implications of adopting this approach. In essence, the delta-strike\r\n selection method\r\n provides an efficient, adaptable framework for managing covered call strategies across a diverse\r\n portfolio, under various market conditions.\r\n
\r\n \r\n Implementing a delta-based strategy has several notable implications:\r\n
\r\n\r\n \r\n 1. Consistency Across the Portfolio: By setting a consistent delta target, investment managers\r\n can\r\n ensure a\r\n coherent balance between yield and upside potential across all securities in the portfolio. This\r\n consistency\r\n can result in a more predictable risk profile, regardless of the differences in the volatility or\r\n other\r\n characteristics of the underlying securities.\r\n
\r\n\r\n \r\n 2. Flexibility in Market Views: A potential advantage of a delta-based approach is its adaptability.\r\n An\r\n investment\r\n manager can modify the chosen delta based on changes in market views or the risk appetite of\r\n their\r\n clients.\r\n For instance, during periods of heightened market uncertainty, the manager might opt for a lower\r\n delta\r\n to\r\n favor more potential upside. In more stable periods, a higher delta could be chosen to generate\r\n a higher\r\n yield. This flexibility allows the strategy to dynamically adjust to prevailing market\r\n conditions.\r\n
\r\n\r\n \r\n 3. Facilitates Risk Management: Using delta to select strike prices facilitates better risk\r\n management.\r\n By\r\n using the same delta across the portfolio, the manager can maintain a consistent trade-off\r\n between yield\r\n and\r\n upside potential, potentially mitigating the risk of creating exposures inconsistent with objectives.\r\n
\r\n\r\n \r\n 4. Operational Efficiency: A delta-strike approach simplifies the process of strike selection.\r\n Rather\r\n than\r\n attempting to predict price movements or manually adjust strike prices, investment managers can\r\n use a\r\n straightforward, systematic approach. This operational efficiency can free up time and resources\r\n to\r\n focus on\r\n other aspects of portfolio management.\r\n
\r\n\r\n \r\n 5. Alignment with Investment Objectives: Investment managers can choose a delta that aligns with\r\n their\r\n investment strategy's specific objectives and risk tolerance. For example, a conservative\r\n covered call\r\n strategy might employ a lower delta, leaving more room for potential price appreciation. In\r\n contrast, a\r\n strategy aiming for higher income might use a higher delta to maximize yield.\r\n
\r\n\r\n \r\n While a delta-based approach does involve a certain level of complexity, the potential benefits\r\n described here\r\n can outweigh these challenges. As\r\n with\r\n any investment strategy, it requires careful implementation and ongoing management. Still, the\r\n discipline\r\n and flexibility it offers can be a valuable addition to the toolkit of any investment manager\r\n running a\r\n systematic covered call strategy.\r\n
\r\n \r\n )\r\n}\r\n\r\nfunction BufferPerformanceProjectContainer(props) {\r\n const [projectObj, setProjectObj] = useState(null)\r\n\r\n useEffect(() => {\r\n apiGet(keys.API_ENDPOINT.PROJECTS, {id: props.projectId}, globalAuthManager).then(\r\n res => {\r\n const [project] = res.data\r\n setProjectObj(project)\r\n }\r\n )\r\n }, [])\r\n\r\n const contextValue = {\r\n projectObj: projectObj,\r\n projectId: props.projectId\r\n }\r\n\r\n return (\r\n ![\"...\"*/}\r\n](\"assets/img/photos/photo-27.jpg\")
*/}\r\n\r\n 
\r\n