We advocate that you can lower your cost basis, increase your Probability Of Profit (POP) and achieve higher returns by selling Calls against your long stock and turning it into a Covered Call. We even believe that just shorting Calls can outperform a buy-and-hold strategy. Some have questioned how that can be so, given one of the strongest bull markets in history. So is it wise to sell Calls given the propensity of the market to go up over time?
We ran two related studies. Both were conducted in the SPY (S&P 500 ETF) using data from 2005 to the present. We used an ordinary margin account (no portfolio margining). We chose the option expiration cycle closest to 45 days to expiration (DTE). We sold 30 Delta Calls. We only opened a new position after closing the old position. We compared a strategy of being just long the SPY (buy-and-hold) to one in which we allocated different percentages of capital ranging from 10% to 35%. A graph the growth of $1 invested revealed that the greater our capital allocation the greater was the return. Our performance was not as good during the strong bull periods but the money collected from selling premium was greater than the losses. Unsurprisingly, it performed much better during bear moves.
Our second study was conducted with the same basic parameters as the first study. The difference is that In this study we only allocated 25% of the available capital and compared the strategies of holding to expiration and managing early by taking winners at 50% of max profit (if possible). A second results graph showed that managing winners dramatically improved the bottom line P/L. Tom added, “Selling Calls in a Bull market which is a worst case scenario, helped to reduce risk and improved your overall returns by 10% - 16% (over buy-and-hold) covering an eleven year period which means that maybe I got something.”
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the valuable takeaways and the results from our studies showing that selling short Calls over the long term improves overall P/L and reduces risk and does so even during strong bull periods.
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