Tuesday, January 17, 2012

Covered Writing Nonsense

Here is what Horizon ETFs say about covered call writing, “The Investment Manager of HEX will generally write short-term, slightly out-of-the-money call options on the entire portfolio. Covered call options provide a partial hedge against declines in the price of the securities on which they are written to the extent of the premiums recieved.(misspelled). Historically, during strong bull markets, where the underlying stocks are able to drive through the strike price on a frequent basis, buy-write strategies have lagged. And even then, investors would still have generally earned moderate capital appreciation, plus dividends and a call premium. During historical moderate bull markets, range-bound markets and bear markets, a covered call strategy tends to generally outperform its underlying stocks.”

Let us now name a strategy that compels us to hold declining stocks and if they go up we have to give them away. I guess we would call that a covered writing strategy. We can see from our HEX vs. XIU (TSX60 index) there is no partial hedge with both losing about 11.5% from February 2011 to date – this is with income on both products included. The extra income on the HEX is offset by a greater capital loss. The real test for this failed strategy will come if the markets advance over the next several months. To be continued for sure. 

No comments: