Covered Calls and Their Unintended Reversal Bet

Topics - Equities Market Risk and Efficiency Volatility Derivatives

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Covered Calls and Their Unintended Reversal Bet

AQR White Paper

Equity index covered calls have historically realized returns not much less than their underlying index with significantly less volatility. They have realized this performance by providing an exposure to the volatility risk premium in addition to the equity risk premium.

However, another important characteristic of covered calls is nearly universally ignored. Covered calls have a remnant exposure to equity market timing, an artifact of selling options. While portfolio managers typically focus on a covered call’s exposure to volatility, equity timing may contribute more than three times the risk of short volatility and nearly half the risk of its passive equity exposure. In fact, over a quarter of a covered call’s risk may be attributed to equity timing. More than likely an unintended risk exposure, equity timing is a significant component of a covered call’s return. This paper seeks to further our understanding of covered call strategies by shining a light on covered calls’ embedded timing of the equity market.

It is important that investors and portfolio managers understand the risks they are taking when owning a covered call. By exposing these risks, we invite investors to assess the appropriate course of action for their portfolios. We believe the portfolio can and should be hedged against exposures to market timing so that the limited risk budget may be allocated to compensated risk premia.

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The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.


Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. The hypothetical performance shown was derived from the retroactive application of a model developed with the benefit of hindsight.  Hypothetical performance results are presented for illustrative purposes only.


Diversification does not eliminate the risk of experiencing investment loss.


Certain publications may have been written prior to the author being an employee of AQR.

This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.


AQR Capital Management is a global investment management firm, which may or may not apply similar investment techniques or methods of analysis as described herein. The views expressed here are those of the authors and not necessarily those of AQR.