Investors who invested billions into funds designed to shield against market volatility experienced significant losses during this week’s stock market downturn, highlighting the risks for retail traders seeking seemingly simple strategies to navigate market uncertainty.
In recent years, “covered call” ETFs have surged in popularity, with assets under management growing from approximately $18 billion in early 2022 to around $80 billion by July, according to Morningstar data. These strategies involve purchasing a diverse set of stocks and simultaneously selling derivatives linked to these assets to generate income.
The appeal of covered call strategies has been driven by their promise of equity-like returns combined with bond-style income and reduced volatility. JPMorgan’s Equity Premium Income fund (JEPI), the largest actively managed ETF in the US, advertises itself as a means to deliver a significant portion of the S&P 500 index returns with less volatility.
However, during periods of rapid market movement, the relatively modest income from selling options fails to compensate for declines in the underlying stocks. Many of these funds have faced both underperformance and sharp fluctuations.
The CBOE’s S&P 500 Buywrite index, a key gauge for covered call strategies, fell 2.8 percent on Monday, only slightly better than the S&P 500’s 3 percent drop. While the S&P 500 remains up 9 percent year-to-date, the Buywrite index has increased by less than 4 percent.
“These funds are not well-suited to handle volatility,” said Ronald Lagnado, research director at Universa Investments, a firm specializing in hedging against severe market downturns. “They’re marketed as income strategies, but essentially, you’re selling volatility. This approach can work over extended periods but can suffer significant losses during severe market crashes.”
The defensive allure of covered calls gained traction in 2022, as both equity and bond markets experienced gradual declines. Nonetheless, Lagnado noted that, over the long term, the performance of covered call strategies is comparable to a traditional 60/40 portfolio of stocks and Treasury bonds.
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