I know this concept gets brought up as a joke sometimes, but I just had a serious conversation with a beginner about it, so Iām inspired to offer some clarity. When people say covered calls have ācapped upside,ā I think two different ideas sometimes get mixed together. First, capped upside does not mean your entire portfolio return is capped. It refers to the upside of the underlying above the strike price during the life of the option. If you own something at $100, sell a call with a $110 strike and collect a premium, you can still benefit from the underlying rising from $100 to $110. Your return can be a combination of: Capital appreciation + option premium If the market moves sideways, the premium can help. If it falls modestly, the premium can soften the loss. If it rises but stays below the strike, you can participate in that rise while also keeping the premium. Itās only once the underlying rises substantially beyond the strike that you start seeing the opportunity cost of the covered call relative to simply holding the underlying. I think this matters because otherwise ācapped upsideā can accidentally turn into a strawman where people hear it as: āCovered call investors canāt benefit when stocks go up.ā That isnāt true. The second point is why many people still favour simply owning the underlying for long-term investing. If you own an asset because you believe it has substantial long-term appreciation potential, repeatedly selling calls against it means repeatedly creating periods where some of that upside can be surrendered in exchange for premium. Sometimes that trade works very well. Sometimes the premium more than compensates you for the upside you gave away. But over a long investing horizon, an asset that experiences large upward moves gives you more opportunities to run into that cap. That is the actual trade-off. āCapped upsideā doesnāt mean no upside. It means you are getting paid a premium in exchange for agreeing to give up some upside beyond a defined point.
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57 Comments
Chad Tameling@tamsy Ā· 19h
The last few years have been very interesting. I own both the underlying stocks and their ETF's in some cases. In the current bull market you probably are limiting your returns a bit but in the previous flat markets the distributions would have been much more desirable. If you are making money and it fits your investment strategy go for it. Just keep investing and it should all turn out.
Moe @moementumfinance Ā· 14h
Thanks @karyungtom for taking emotions out if it and explaining it in simple terms and with respect. At the end of the day, it is not about saying one strategy is right and the other is wring. It is about knowing the trade-off and ultimately making the choice that is right for our own portfolio and circumstance. May all Blossomers continue do well and be well on their path to reaching financial independence! Cheers š„
ETF Go@etf.go Ā· 11h
The ācapped upsideā counter argument has definitely been overused. That said the structure introduces a number of performance hurdles that traditional ETFs never had. There are likely a lot worse things people can do with their money than invest in CC ETFs. But people should consider the pros and cons of every strategy. Everything has a use case and time/place. Itās when strategies get over used that often lead to unintended consequences. šš
Michael Conroy@conroy119 Ā· 19h
Yup well said! Also, since you are SELLING a CALL, this gives the owner of that buyer the ability to exercise it. So at any point in time the shares can be called away. Basically forcing the fund to buy back in at a bad price. Maybe even a net loss. Since these funds are designed to perpetually selling calls agains the same holdings. Whereas an individual would likely wait to buy back in at a lower price. Or re allocate the funds elsewhere.
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