Coverage can be a good thing – and not just for the general public’s viewing. Take covered call options, for example.
According to Brian Overby: “Covered call selling (or “writing”) may offer a relatively low-risk way to generate income on existing stock positions in sideways or range-bound markets.” In other words, coverage can generate warm profits even in times of a still-blustery economic climate.
Unfortunately, thanks to months of cratered portfolio performances, not to mention that inexorably approaching dysfunctional stress factor called “The Holidays,” many investors still prefer the instinctual safety of running with the crowd at this time. Can we really blame them?
However, here’s some hard data support to cheerlead Mr. Overby’s position (no pun intended). Earlier this year, the Wall Street Journal reported on the CBOE BuyWrite Monthly Index (BXM) findings and found:
“Over the past two years, someone who invested in a regular S&P 500 index fund would be down 43%. At the lows, early last month, they were down 54%.
Over the same period, someone following the BXM would have lost a much more modest 25%. At the worst point they were down 37%.
Over a ten year period, buy-and-hold investors in the total US stock market have lost about 2% of their money. Investors pursuing a BXM strategy would be up about 13%.
But the real appeal of this strategy emerges over twenty years. From April 1989 to the present, the BXM has made total returns of about 400% — slightly ahead of the broad US equity market. In other words, the buy-write index beat the stock market, with a lot less volatility.”
It appears that covered call options might just be one of those income-generating secrets unfortunately saddled with an overly risky name. Here are some ways to find out whether this investment method might be that little extra vitamin boost for a Scrooged portfolio:
“Very nice,” the now-savvy investor might say, “but let’s not move so fast here. What about short-term/long-term capital gains tax ramifications?”
Well, that depends on whether you’re writing calls in a sheltered (IRA) or non-sheltered account. For non-sheltered accounts, Allan Ellman discusses tactics in his Blue Collar Investors blog but for those CPA-minded individuals who want to hear it directly from the horse’s mouth, specific tax information can be found in IRS Publication 550, Investment Income and Expenses, pages 57 – 58.
Last, but not least, if covered call options do happen make it to the 2010 New Years’ Investment Resolutions List, keep in mind that not all brokerages will allow writing covered calls. The best course of action is to first decide if this is something to pursue before researching which brokerage company can best suit your new investment strategies.