Covered Call Strategy

Income Generation and Portfolio Diversification

The goal of our Covered Call Strategy is to enhance total return by generating income and providing limited downside protection. Income from selling the call options is received in exchange for future price appreciation over the strike price of the call option. The strategy is most beneficial during a period of flat to slightly positive market returns as the client collects both dividends on the underlying shares and income from selling the call options. We also build customized option strategies based on individual client needs.

What is a covered call?

A Covered Call portfolio is constructed by selling call options on stocks that are owned in a portfolio. The sale of call options produces income, which is received in exchange for future price appreciation over the strike price of the call option. The goal of our Covered Call Strategy is to enhance total return by generating income and providing limited downside protection.

What is a call option?

A call option gives the owner the right to buy a stock before a specified date (expiration) and at a specified price (strike price). In a Covered Call portfolio, this right is sold to someone else in exchange for income.

Do options increase the risk in my investment portfolio?

While certain option strategies can be high risk, covered call writing actually lowers the risk of a stock portfolio. The income received from selling call options reduces the volatility of a portfolio, which means the portfolio loses less money in bear markets and makes less money in bull markets. Although WWM utilizes covered calls to reduce volatility in portfolios when appropriate, there are some risks associated with this strategy.  For example, the shares associated with the option may be called away if they trade above the exercise price prior to the date the option expires. As a result, the writer of a call option may partially or entirely forgo the opportunity to benefit from an increase in value of the underlying shares above the option price but continues to bear the risk of a decline in their value. Also, if the call is exercised, this could generate tax consequences.

What type of stocks are best for this strategy?

We identify stocks with minimal downside risk to current price levels and modest upside potential. Large cap stocks are targeted due to the significant liquidity advantage in the options market that large cap stocks hold over small caps. The universe of large cap stocks that are candidates for Covered Call portfolios is derived from our core, large-cap quality growth equity process.

When is this strategy most effective?

A Covered Call Strategy works best in a relatively flat or slightly positive market environment. In these scenarios, the owner of a Covered Call portfolio receives income from writing the call, dividend income from the underlying stock, and modest appreciation potential of the underlying shares.

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