Are Covered Calls Less Risky than Passive Strategies?
In The Only Guide to Alternative Investments You’ll Ever Need: The Good, the Flawed, the Bad and the Ugly, author Larry Swedroe questions claims that covered calls are less risky (when risk is measured by the standard deviation of returns) than long-only portfolios. He points out that in a covered call strategy, the distribution of returns is not “normal” and that standard measures such as the Sharpe ratio are not very useful in measuring risk.
Classifying covered calls a “flawed” alternative investment, Mr. Swedroe notes that the strategy has two undesirable traits: (1) The returns exhibit negative skewness (Skewness is a measure of the asymmetry of a distribution) and (2) The strategy eliminates the potential for a highly positive return while having no impact on the potential for an extremely negative return (Kurtosis risk).
Mr. Swedroe concludes:
While covered-call strategies appear to promise “a free lunch” of increased returns with less risk, investors who care about more than the volatility of returns will not find this an efficient strategy.