Covered Calls, Puts, & Equities
Original Words:
I am going to dive into our covered call and Put hedging strategy right here. This strategy works great on two risk profiles: Moderately Aggressive (75/25) and Moderate (50/50). The strategy has defined loss characteristics built in with the Puts and also has an income objective with the covered calls.
Take for moderately aggressive vs the benchmark of 75% equities and 25% bonds. On $30,000,000 dollars under management my Put cost is $748,601 or (748,601/$30,000,000) = 2.49% of the total capital. That is Put gives you a 20% downside protection and then we could turn around and pay for that hedge with covered calls. We would write covered calls monthly or do a big trade that would cap your upside 12-18 months in the future.
Lets says we wrote a covered call at 720 strike which is out of the money by ($720-$610 todays price = $110). That could generate us $684,622 in capital. We take the $748,601 cost of puts and subtract $684,622 from covered call written we get $62,979. This $62,979 is the cost of your puts at this point. What we just did though was we capped upside to $720. If the QQQ goes above that you lose out on the gains and could be forced to sell if the QQQ shares you own are called away.
The total cost? 62,979/30,000,000 = 0.20% + Mgmt. Fee of 0.60% for a total cost of 0.80%. That caps your downside at 20% plus cost of puts which is now 0.20% for a total downside of 20% + new put cost 0.20% + Mgmt. Fee of 0.60% for a total cost (if the market is 2008 again) of 20.80%. If the market doesn’t fall out and it is normal then your total drag is only 0.80%. Which historically in all likelihood is what it will be. The 20% protection only kicks in once the market price of QQQ falls below the strike price. On the model I just ran the strike we used was $490.
Some things to note: The more volatile the market is the more the Puts cost. Last year when the market was really stable before the AI fears and valuation fears kicked in on Q4 I was getting drag number for out moderate risk profile model of 3.8-4.0 percent. Now that it is pushing 4.42-4.55 when annualized.
In the scenario I laid out above with the moderately aggressive risk profile/model we hedged your downside and capped your upside. We allowed for a run of QQQ up to $720 or 17.74% between now and option expiration which is January 15, 2027. You are gated for your returns and losses of -20.80% and 16.94% (17.74- .20 - .60 = 16.94) during that time frame.
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Covered Call + Put Hedging Strategy
I want to walk you through how our covered call and put hedging strategy works. This approach is designed specifically for two risk profiles:
Moderately Aggressive: 75% equities / 25% bonds
Moderate: 50% equities / 50% bonds
The strategy has two built-in objectives:
Defined downside protection using put options
Income generation using covered calls to help offset the cost of that protection
Example: Moderately Aggressive Portfolio (75/25)
Assume:
Assets under management: $30,000,000
Equity exposure: QQQ
Step 1: Buy Downside Protection (Puts)
Cost of puts: $748,601
As a percentage of the portfolio:
748,601÷30,000,000=2.49%
These puts provide 20% downside protection on the equity portion of the portfolio.
Step 2: Offset the Cost With Covered Calls
To help pay for the puts, we sell covered calls:
Example call strike: $720
Current QQQ price: $610
Upside before the cap:
720−610=110 points (out of the money)
Selling this covered call generates:
$684,622 in premium income
Step 3: Net Cost of the Hedge
Put cost: $748,601
Covered call income: $684,622
Net cost:
748,601−684,622=62,979
As a percentage of total assets:
62,979÷30,000,000=0.20%
Total Ongoing Cost
Net option cost: 0.20%
Management fee: 0.60%
Total annual drag:
0.80%
What Are You Giving Up?
By selling the covered call:
Your upside is capped at $720
If QQQ rises above $720, you stop participating in further gains
You may be required to sell shares if they are called away
What Happens in a Major Market Decline?
Downside protection: 20%
Net option cost: 0.20%
Management fee: 0.60%
Maximum downside in a severe market (e.g., 2008-style event):
20.80% total
The protection only activates once QQQ falls below the put strike price.
In the model run, that strike was $490. With that said, that is when you can exercise the puts. The value of the puts will increase when the market becomes volatile and is headed down.
Volatility Matters
When markets are calm, put options are cheaper
Last year (pre-Q4 volatility), the annualized drag for the moderate model was about 3.8%–4.0%
With higher volatility today, that drag has increased to 4.42%–4.55% annualized
Higher volatility = higher insurance cost. Longer in the future = cheaper when you annualize the costs.
Final Outcome of This Strategy
Using the moderately aggressive model, we:
Cap downside: –20.80%
Cap upside: +16.94%
Breakdown of upside cap:
Maximum price gain to strike: 17.74%
Less option cost: 0.20%
Less management fee: 0.60%
Net upside: 16.94%
Timeframe: Now through option expiration on January 15, 2027
Bottom Line
This strategy intentionally gates both risk and return:
You give up some upside in exchange for defined downside protection
In most market environments, the expected drag is relatively low
In severe drawdowns, the protection becomes extremely valuable
Call income can be written monthly as well. Call income is considered short term capital gain regardless of length until expiration.
Writing monthly covered calls during a sharp market drawdown (e.g., –10%) can be risky due to elevated volatility. The market can rebound quickly, and if QQQ rallies through the call strike, upside participation may be capped and gains missed. This is why understanding each client’s risk tolerance and objectives is critical when implementing this strategy. Historically, simply owning QQQ with an annual put hedge (roughly a 5% drag) performed very well over the past 20 years. However, today’s environment is different. We are no longer emerging from a once-in-a-generation economic crisis. Valuations are higher, inflation remains sticky, and forward-looking risks—such as sovereign debt, entitlement funding challenges, and geopolitical uncertainty—make the market more fragile, particularly as we approach the 2030s. While the strategy still works, I believe it must be applied more carefully given the risks at hand in the current and future American and world economies.
