Research Piece: Why Selling In-The-Money Covered Calls Is A Great Strategy


After having published the article about playing defense with covered option selling strategies, it's time to take a look at an example showing the true power of in-the-money covered call writing. Does it generate consistently positive returns? What kind of market environment are we looking for to put these trades on and more specifically: when do we reach our maximum profit potential? Based on 9.5 years of historical data on American Tower, which is one of the long-term elite performers, we can take a look at the performance of different 1-year in-the-money covered calls and their respective standard deviation. American Tower typically sees 17% historical and thus realized volatility, whereas longer-term call options have been pricing 21% (on average) over the past decade. Just pull up a price chart on AMT and you'll see the consistency many shareholders have enjoyed so far. We believe that AMT is a good investment for defensive long-term focused investors, but with covered options strategies it's an even better play.

Empirical Research

Is there an edge of selling in-the-money covered calls into high implied volatility? Or do we get a fairly consistent picture across board (thus in every IV environment)?

This empirical research piece breaks down the data from June 2010 to June 2019. We've analyzed the forward and realized 1-year returns for both 1-year in-the-money covered calls and buying stock (excluding dividends), i.e. the return from June 2010 to June 2011; from July 2010 to July 2011 and so on. Basically, more than 110 months of reference points were plotted. Also, we looked at 30 different months with an either normal or high volatility and tracked the performance of in-the-money covered calls throughout the year on a monthly basis.

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The Results For A 5% ITM Covered Call (1 Year Duration)

Buy-and-hold performance

Buy-and-hold investing when initiating a position every single month would have yielded an average 1-year forward return of 12.3% with 12% standard deviation. Over the time span, 83% of all occurrences have been profitable with 44% of them exceeding a +15% return. It should be noted that 2 SD outlier moves in AMT's returns are positively skewed. The 1 SD levels are highlighted in the dot graph.

(Source: Option Generator Research)

5% ITM Covered Call

For the 5% in-the-money covered call, the return picture looks increasingly attractive. Continuously selling an in-the-money covered call (hypothetically speaking regardless of the VIX environment) every single month would have yielded an average 1-year forward return of 5.1% with 1.8% standard deviation. Statistically speaking, this observation implies a better probability of success if, ergo: it's not a 50/50 shot. Fewer outliers, no negative returns and narrower distribution ranges. What's important to note is that huge spikes in the forward returns are very uncommon and short-lived, as a surging VIX is not a typical phenomenon.

(Source: Option Generator Research)

Linear Relationship Between Forward Returns and Implied Volatility

The following statement should be familiar to covered option sellers: with higher implied volatility comes higher reward. Based on the bubble chart below, that's indeed correct. The higher the IV, the greater our credit (potential reward) and ultimately the higher our final return. From a buy-and-hold perspective with AMT, the advantage of buying stock into IV strength is not pronounced.

(Source: Option Generator Research)

Time Until Reaching Maximum Profit

The average implied volatility for AMT has been 21% over the last decade. Let's break those various IV levels down into three segments.

When it comes to the return evolution of trades with 30 different IV levels, there are two elements that stand out to us.

  1. Trades with the highest potential returns (and thus ITM covered call positions entered in high VIX environments) tend to reach their maximum profit pretty fast

  2. Positions that have a lower return potential see more deviation in their P&L (relatively speaking). Stated differently, their risk-adjusted returns are worse.

(Source: Option Generator Research)

Selling ITM Covered Calls Into High IV

Highlighted in the graph below, I tracked the performance of 4 ITM calls sold in IV of 30+ %. As for AMT, these kinds of elevated levels are unusual.

(Source: Option Generator Research)

Nonetheless, when they show up they are set to reward us generously not only because of the juicy options credit, but also the pace at which we lock in nice profits. Most of the time, 80% of max. profit is already realized within 2-3 months. Why? Because of contraction in implied volatility, which pulls the time value left in the option down.

Should you ride the other 9-10 months out, knowing you won't generate any additional profits? Definitely not! We can sell monthly at-the-money or out-of-the-money covered calls against our long position. Because of this hybrid framework, our actual results could have been improved even more. It's the ecosystem of various covered strategies with different features/goals that make options so attractive.

The question becomes: do we better adjust our strikes based on the share price or do we stick to the same strike when a correction takes place? The latter strategy is meant for those looking to not cap their upside during a recovery, as shown by the red line. The strategy had 21% lower standard deviation, but yielded 2% less than the common shareholder on an annualized basis. The green curve represents the return you would have generated when selling a monthly at-the-money covered call and continuously adjusting the strike based on AMT's share price. In very volatile times, the green curve does not provide a meaningfully higher risk-adjusted return. In fact, the opportunity cost during recoveries/rallies (because of being capped on the upside) considerably exceeds the benefits from collecting a higher credit during corrections.

(Source: Option Generator Research)

Selling ITM Covered Calls Into Higher IV

Now focusing on 25+ % IV occurrences, we see more standard deviation in the returns for lower-reward positions. Also, it takes longer to reach 80% of maximum profit (about 5 months versus 2-3 months in high IV).

(Source: Option Generator Research)

Low-to-normal IV

As for sub-25% IV, a larger percentage of all occurrences yields more negative intra-year returns. The time required to lock in 80% of maximum profit is substantially longer, while that maximum profit potential is mediocre compared to returns achieved in high IV.

(Source: Option Generator Research)


For defensive investors looking to avoid drawdowns, selling in-the-money covered calls has worked out pretty well over the past decade. Based on this empirical research piece, high implied volatility automatically leads to an elevated return potential, as anyone could have expected beforehand. The most intriguing part about this study on AMT (it will be expanded to other stocks and industries) is that you can expect fast profits to be made within 1/3 of the duration. When reaching max. profit, turn to monthly at-the-money or out-of-the-money covered call writing.

I hope this article has demonstrated the true power of playing defense with in-the-money covered calls, especially in high IV. In-the-money covered calls are a key component of our portfolios as they provide relatively stable long delta, positive time decay and pull down our overall standard deviation (and thus drawdown risk).

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