A Devil's Bargain: When Generating Income Undermines Investment Returns

Forthcoming, The Journal of Alternative Investments, https://www.pm-research.com/content/iijaltinv/early/2024/03/10/jai20241211

Posted: 27 Oct 2023 Last revised: 3 Apr 2024

See all articles by Roni Israelov

Roni Israelov

Independent

David Nze Ndong

affiliation not provided to SSRN

Date Written: October 26, 2023

Abstract

Many investors are motivated by passive income. Dividend income seeking strategies have a long history. More recently, interest in derivative income strategies – such as covered calls and put underwriting – continues to develop. Do high derivative income covered calls tend to deliver higher total returns? No. In fact, the relationship goes the other way. We demonstrate a strong negative mechanical relationship between expected total return and derivative income for covered call strategies. We empirically validate this relationship over a nearly 25-year period on S&P 500 Index covered call strategies. Those who have sought out and allocated to such strategies without taking into account this tradeoff might have made a devil’s bargain.

Keywords: Covered Call, Covered Calls, Call Overwriting, Overwriting, Options, Volatility Risk Premium, Variance Risk Premium, BuyWrite, Buy-Write, PutWrite, Put-Write, Yield, Income, Derivative Income

JEL Classification: G00, G10, G11, G12, G13

Suggested Citation

Israelov, Roni and Nze Ndong, David, A Devil's Bargain: When Generating Income Undermines Investment Returns (October 26, 2023). Forthcoming, The Journal of Alternative Investments, https://www.pm-research.com/content/iijaltinv/early/2024/03/10/jai20241211, Available at SSRN: https://ssrn.com/abstract=4580048 or http://dx.doi.org/10.2139/ssrn.4580048

Roni Israelov (Contact Author)

Independent ( email )

United States

David Nze Ndong

affiliation not provided to SSRN

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