The data is available for download at the CBOE. But I've saved you the trouble and show the data in graphical format. The performance of each of the three buy-write indexes is compared with a simple buy and hold for the same index.
When you look at the graphs, it's important to know that the time periods differ widely. BXM was constructed earlier than the others, and although it may be possible to collect and use data from earlier times, it has not be done (BXM is available back to 6/30/1986).
BXM: The CBOE S&P 500 BuyWrite Index
These two indexes have been averaging similar results most of the time. During the very strong, bubble-building years of the late 1990s, buy and hold, as represented by the Standard & Poors Total Return Index (SPTR) performed much better than a portfolio that held the same stocks, but against which covered calls were written.
And that makes sense. Writing covered calls limits potential profits. That's the price that must be paid during raging bull markets. But such markets are not common and writing covered calls outperforms sufficiently to make up for those very bullish years – for this portfolio – an investment in the 500 largest companies listed for trading.
When the bubble-bursting market decline began, BXM, the Buy-Write Index outperformed and made up for those under-performing years. During the recent rally (since March 2009), the unhedged portfolio has once again done better, and SPTR has almost caught up with BXM.
The bottom line for investors is that during the 21 years of available data, those who wrote ATM covered calls fared at least as well as those who owned a diversified portfolio of large cap stocks.
Question: Is this result good enough to claim that covered call writing provides 'enhanced returns'? Probably not in dollar terms. But what is true is that BXM provided a less volatile, smoother ride for those who adopted this strategy. Reduced volatility is very desirable, and although most unsophisticated investors prefer to see extra profits, the idea of owning a portfolio that provides less volatile returns ranks near the top of the list of 'good attributes' for an investment portfolio.
Please note: It's not a good idea to replicate the BXM strategy by owning all stocks in an index and writing index calls. It's simpler to buy ETFs that mimic the performance of the specific index that interests you, and write covered calls on that. The proper ETF for mimicking the BXM strategy is SPY. You can use QQQQ as a substitute for NDX and IWM to represent RUT.
For large cap stocks,
BXM performs well. How about buy-writes for other indexes?
BXN: The CBOE NASDAQ-100 BuyWrite Index
This graph illustrates what can happen when the market rises so rapidly that covered call writers are left far behind. In 1999 the performance of NDX (NASDAQ 100 Index) is so much better than that of BXN (CBOE NASDAQ 100 BuyWrite Index), that I truly find it difficult to believe. During 1999, NDX more than doubled from 454 to 917. During the same year, BXN was up by 43%, but that outstanding return was dwarfed by the bullish performance of NDX. Those who rode the rally unhedged collected big time. On this graph, that 43% return for BXN looks unimpressive.
As we now understand, that huge rally was based on nothing more than hope, and those Internet companies were not worth the prices at which they were trading.
By year end 2002, the excessive gains of NDX were wiped out by the market decline and the two indexes were trading near the same levels (NDX was still higher). If the bulls never exited or hedged their positions, as most didn't, the out-performance soon disappeared.
This demonstrates that a volatile index, such as NDX can perform much better during rallies, but also much worse during declines. In simper terms – it's a very volatile index and writing covered calls reduces that volatility, but at the expense of smaller profits. At least that's the story over the limited lifetime of the available data.
Bullish investors may not be well served by any strategy that limits profits. But, not every bullish investor is aggressive, and deciding whether to hedge (reduce the risk of owning) a portfolio is one of your major decisions.
BXR: The CBOE Russell 2000 BuyWrite Index
Over the 9 short years for which data is available, there is little to recommend either strategy – although buy-writing has the edge. The interesting data is missing – and that's the bubble years from 1998 through 2000. It's very likely RUT outperformed it's buy-write index during those years.
I'm attempting to draw valid conclusions from the data, but we must remember that data covering 10 to 21 years is not likely to tell the whole story. We have seen some strong markets and some weak markets, and that tends to make the data more reliable.
Your task is to gather information that allows you make a decision on how to invest/trade. Investors want to build a portfolio that suits their needs. Reducing risk should be (ok, that's my opinion, not a fact) near the top of those needs.
Writing covered calls is a worthwhile strategy. It provides the comfort of a less volatile portfolio, and depending on the type of stocks owned (large cap vs smaller, highly volatile companies) can even provide better returns. Reduced volatility with good returns is a big plus.
But, covered call writing is a bullish strategy and does not fare well in bear markets. It's much better than buy and hold. But what about the conservative investor who prefers much more protection against large losses? After a short break, we'll continue with a discussion of collars.