TABLE OF CONTENTS To evaluate portfolio performance, one needs to consider the risk associated with generating returns. Traditional performance metrics evaluate returns relative to the standard deviation of returns. These moments do not adequately take into account measures of interest to investors. Using improved risk-adjusted performance measures, we find the covered call portfolio is not an adequate investment strategy. Rather, investors are better off by holding the market index.
Keywords: Covered call investing; upside potential ratio; performance measures.
The popular press touts the covered call investing strategy as a means or reducing risk while increasing an investor's return. In the academic literature, however, there is a lack of agreement on when to use the covered call strategy, and even if the strategy has value at all (Baldwin, 2002; Einhorn, 2001; Rattiner, 2001; Thackuk, 2000). Part of the difficulty stems from the fact that the metric we use to evaluate the performance for any investment strategy is questionable. While investors understand the concept of evaluating performance on a risk- adjusted basis, the traditional measure of risk may be inadequate. Additionally, recent studies question the means for determining return and the metric against which we gauge performance.
In this paper we will compare the risk-adjusted performance of two portfolios: an index portfolio and a covered call portfolio. To compare the strategies' success, we evaluate performance with three metrics: the Sharpe ratio, Sortino ratio,...
