Covered call strategies allow investors to seek high income potential without taking on additional duration or credit risks. They also may benefit in periods of elevated market volatility, making them a noteworthy addition to income portfolios.
“Monetizing equity market volatility is an attractive source of structural cash yield generation,” explained Eric Granat, CAIA, PM/derivatives analyst, Fidelity Investments. He discussed covered call strategies at the 2024 Alternatives Symposium hosted at the end of May on the VettaFi platform. Fidelity seeks to offer investors downside risk management through its options strategies, as well as income via its covered call funds.
Options allow for a great deal of customization to fit a variety of desired investment outcomes. Some options strategies offer downside protection or hedging. Covered calls seek to generate income across various market environments. They also provide the potential for a measure of downside mitigation should stocks decline. Premiums earned on the covered calls may help to cushion some of the loss in down markets.
Looking back at the gradual and consistent decline of stocks in 2022, covered call investors benefited in a challenging year.
What to Expect This Year for Covered Call Strategies
Covered calls aren’t hedges; “They’re not long put allocations, they’re not long contractual defensiveness,” noted Granat. “Monetizing inflated market volatility premiums in sideways and declining markets is a really attractive option for individuals looking to make drawdowns a little bit shallower and a little bit shorter in duration.”
Fidelity brings nearly four decades of experience in options investing to bear in managing its ETF suite. This experience spans a range of market and economic environments.
The firm offers an options-based equity ETF suite consisting of three funds that cover a range of drawdown risks and risk tolerance levels. One fund offers elevated options-based yields, while the other two provide defensive positioning.
“We want to use options to go after a broad set of risk appetites,” explained Granat.
Options Investing With Fidelity
The Fidelity Dynamic Buffered Equity ETF (FBUF) and the Fidelity Yield Enhanced Equity ETF (FYEE) both use covered calls. FBUF seeks capital appreciation and invests in large-cap companies while using a “defensive option collar” to mitigate risk. The strategy buys puts to offer downside protection and sells covered calls to fund the purchase of those puts. On the other hand, FYEE seeks current income by investing in large-cap companies while selling out of the money covered calls to generate income.
Meanwhile, the Fidelity Hedged Equity ETF (FHEQ) focuses solely on defensive positioning through the strategy’s use of long puts. The fund seeks capital appreciation by investing in large-cap companies while using put options to provide downside protection during sharper market draw downs.
“Options are more widely traded among individuals and institutions than ever before, certainly in my 24-year career,” Granat added. At Fidelity, “we have the options-trading expertise, the ETF development expertise, so we wanted to put these [products] out to display the capability that we’ve built over the last decade.”
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