"Use Options ‘Overwriting’ to Boost Yield, Morgan Stanley Says
By Jeff Kearns
April 15 (Bloomberg) -- Investors who own stocks should sell options on them using an “overwriting” strategy to increase returns because stock market volatility is elevated and the rally since March 9 may not last, Morgan Stanley said.
The strategy involves selling call options that become profitable when the underlying shares climb by a fixed amount. A trader owning the position is betting the security won’t rise enough to trigger the option, leaving him with the proceeds of selling the call.
“Overwriting strategies work well when we do not have large and sustained equity rallies,” strategist Sivan Mahadevan wrote in a note. “As a long-term strategy, they have historically offered attractive risk-adjusted returns, but our focus here is more near-term in nature.”
The Chicago Board Options Exchange S&P 500 BuyWrite Index, or BXM, tracks the performance of selling calls a month from expiration once a month using contracts about a month from expiration. The gauge is up 0.2 percent this year before today, while the Standard & Poor’s 500 Index has lost 6.8 percent. The stock benchmark has rallied 24 percent since dipping to a 12- year low on March 9.
“Most investors continue to have little conviction on the direction of stock prices, despite one of the largest one-month rallies in S&P 500 history,” New York-based Mahadevan wrote.
Higher levels of implied volatility, a measure of expected price swings and the key gauge of options prices, mean the yield investors can get from overwriting is “quite appealing by most historic measures,” the strategist said. High volatility lets traders sell calls that are further out of the money and therefore keep more of the gains if stocks rise, he wrote.
The VIX, a benchmark for U.S. options prices, has averaged 44.30 this year, more than double the level over its 19-year history. Bigger market swings mean that options can be sold at higher prices because larger moves give contracts better odds of reaching the strike price at which they can be executed.
Calls give the right to buy a security for a certain amount by a given date. Overwriting involves selling options while already owning the underlying security. The strategy is called a “buy-write” when the investor buys stock and sells options at the same time. Both are also known as “covered call” trades.
“This strategy is the most basic and most widely used,” according to the Web site of the Options Industry Council, an investor education group backed by the seven U.S. options exchanges and the Options Clearing Corp. “The covered call is widely regarded as a conservative strategy because it decreases the risk of stock ownership.”