In the heat of summer, returns across both stocks and bonds were decidedly cold. The main driver of underperformance for the month was expectations of the future path of interest rates.
Two proven methods of generating extra income for client portfolios are tax-loss harvesting and writing covered calls.
Tax-loss harvesting is the time-tested practice of selling investments at a loss in order to minimize tax liabilities. For example, suppose an investor purchased 100 shares of Exxon for $80 and later sold it at $113, for a capital gain of $3,300 (100 x $33). At the same time, the investor purchased 100 shares of Microsoft for $295 and sold it later for $263, for a capital loss of -$3,200 (100 x -$32). The loss of $3,200 would almost completely offset the gain of $3,300 and save the investor 20% x $3,200 = $640 in taxes.
Writing (selling) covered calls is another way to generate income/reduce losses from current holdings. A call option is the right to “call away” shares at a predetermined “strike” price on a given expiration date. The options are packaged in 100 share units. In general, an investor has at least one of three objectives when writing covered calls: yield enhancement, reducing a position at a favorable price, or target price realization.
Yield enhancement is achieved by selling call options on equity shares that the investor already owns. From the Bloomberg Options Tables on February 7, 2023:
• AAPL(Apple) was trading at $153 per share. An owner of the stock could sell a March 17 call with a price of $155 per share and receive $4.85 per share from the call purchaser.
• SPY (SPDR S&P 500 ETF) was trading at $410, and an owner could sell a March 17 call with at a price of $411 for $9.76.
• MSFT(Microsoft) was trading at $262, and an owner could sell a March 17 call with at a price of $265 for $8.40.
At the end of trading on March 17, the results of this call writing strategy for this hypothetical portfolio of three securities is as follows:
|Share Price (Feb 7)||Call Premium Received||Share Price (Mar 17)||Final Value Received|
|MFST||262||+8.40||278||$273.40 (share called at $265)|
• The portfolio without the call premiums LOST .2% over the 38-day period, annualized -2.3%.
• The portfolio that wrote the calls EARNED 1% total return, annualized +9.6%.
JP Morgan Equity Premium Income ETF (JEPI) or Mutual Fund (JEPIX) may be in your portfolio managed by Central Trust Company. This strategy consists of 128 equities with a weighted average market capitalization of $198 billion and writes covered calls against those holdings. In 2022, JEPI posted a loss of 3.5% as compared to an 18% loss for the S&P 500. By most measures, the fund has below market volatility and risk. Most of this outperformance was attributable to the call premiums received. The fund features an SEC Yield of 11.77%. (Source: JP Morgan).
Writing call options is characterized as low risk, except the opportunity cost if shares go up beyond original price plus premium. There is no counterparty risk since the cash premium is collected in advance of the contract. If your forecast is for a “trendless”, declining, or flat market, writing covered calls can enhance portfolio returns and mitigate downside risk.
Our investment philosophy at Central Trust Company is grounded in the fact that the most important part of building a portfolio is through the discovery of your goals, objectives, time horizon and expectations. By including a broad range of asset classes, building allocations based on forward-looking market assumptions, and leveraging many of the best investment management firms in the world, we can help clients meet their objectives regardless of volatility in the market.