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Income from Options: Understanding Covered Call Strategies with Howard Chan

• Michael A. Gayed, CFA

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Are you aiming for steady income from your investments? Discover the ins and outs of covered call strategies in our engaging episode featuring Howard Chan from Kurv Investments. We dive deep into how this strategy can generate additional returns while strategically managing risks.

Throughout the episode, we unpack the mechanics of writing covered calls and explore the volatility premium's significance in this context. Howard sheds light on when this strategy is best employed and the underlying market conditions that can influence its efficacy. With increasing uncertainty in the markets, the conversation delves into the role of covered calls in achieving a balance between income generation and capital appreciation, particularly for investors focused on cash flow.

The discussion also touches upon technological advancements that have streamlined the use of covered calls, enabling more investors and advisors to incorporate these tactics into their portfolios efficiently. Listening to this episode equips you with perspectives on the complexities of options trading, how to capitalize on various market cycles, and the potential tax benefits related to income derived from covered calls.

Join us as we explore practical insights and expert opinions on optimizing investment strategies for generating stable returns. Don’t forget to subscribe and share your thoughts on how covered call strategies fit into your investment philosophy!


DISCLAIMER – PLEASE READ: This is a sponsored episode for which Lead-Lag Publishing, LLC has been paid a fee. Lead-Lag Publishing, LLC does not guarantee the accuracy or completeness of the information provided in the episode or make any representation as to its quality. All statements and expressions provided in this episode are the sole opinion of Kurv Investments and Lead-Lag Publishing, LLC expressly disclaims any responsibility for action taken in connection with the information provided in the discussion. The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.

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Speaker 1:

What happens with doing a cover call? Essentially, you're doing two things. You can think about it in two different ways. Is that one? You are harvesting this premia that exists in the market, called the volatility premia. Usually, market are pricing volatility higher than the realized volatility, so the premia you're really really harvesting here is the difference between implied volatility versus realized volatility. So the market is willing to price more volatility than is actually being realized, and so you're harvesting that difference between the two. But the second thing you can think about is, over the long term, you are trading some of the upside of the underlying stock for income, or this premium that you're harvesting, right. So a cover call strategy is something that I think you need to be a little bit aware of what market environment you're in to use it in your portfolio. This should be a good conversation with our channel, curve.

Speaker 2:

We're going to talk about cover call strategies, which have been all the rage, and maybe why cover cold strategies could be particularly interesting here at this point of the market cycle, especially as volatility looks like it wants to rise, especially the last several days here. With all that said, my name is Michael Guyatt, publisher of the Lead Lag Report. This conversation is sponsored by Curve Investments. Howard Chan here, the man behind the company. Howard, you and I have done, I think, two of these and we did a webinar in the past. But for those who haven't seen you or heard of you before, introduce yourself. What's your background, how'd you get involved in markets and what got you to start the?

Speaker 1:

company. Yeah well, thank you, michael. My name is Howard Chan from Curve Investment Management of Investment Management.

Speaker 1:

The mission for Curve is to make available tax-efficient, institutional grade strategies to investors of all sizes.

Speaker 1:

Most of us actually formerly worked at larger firms like Goldman and PIMCO, where you just saw that there's this gap in the marketplace where large institutional investors have been using these strategies to generate additional returns in their portfolios. They were not available to everybody, and so our goal was to put it in a vehicle that's easily accessible through a brokerage. But the one thing we had to take into consideration was tax, because many of these institutional investors, such as endowments and pension funds, are non-taxable entities. So when you bring some of the more sophisticated portfolio management strategies into a vehicle that everybody can access, you do need to think about tax. So we try to optimize, for obviously, the very first foremost is to reach the investment objective of the strategies we're running, but also we built in some sort of tax efficiency into all of our strategies. So that's our background, and hopefully we can talk about one of the key strategies that I think people have been using since the 80s to generate some additional income.

Speaker 2:

That's a good teaser. Since the 80s, which I don't even know, that has been something that's been active, although the options market has obviously been around for a long time. Let's talk about covered call strategies. First of all, let's explain what cover call strategies are and why have they been so popular in the last several years.

Speaker 1:

So cover call strategies are pretty simple actually you have an asset, you're long an asset, and then you are writing a out-of-the-money call or shorting a call, and somebody who buys it gives you a premium and that premium you receive can be distributed as income. And so, as I mentioned before, traditionally it was started around maybe the 80s, when people were using this in ultra-high net worth individuals' portfolios and also pension funds. And the reason why I started there was because there was, you know, just for many of these advisors, their group of security sitting in a portfolio. Sometimes they distribute dividends, sometimes they don't, and so the advisors oftentimes these ultra high net worth individuals have cash flow needs. Oftentimes these ultra high net worth individuals have cashflow needs. So instead of selling securities which may have created short-term gains or long-term gains tax liabilities they wanted to generate income in a different way, so to meet their spending needs or something like that. So that's how cover calls sort of started, and it generally was not really democratized until recently, because it is pretty time consuming to do these cover calls.

Speaker 1:

If you're an advisor, the steps that you have to do is you take a look at what is in the portfolio, and many clients have different assets in the portfolio, so it can't be really done on a wholesale basis. You have to figure out how to write the call basis. You have to figure out how to write the call. So if you are at a larger advisory firm, you might have an execution desk who can help you. If you're a smaller, independent shop, you have to do this yourself, which is very, very time consuming.

Speaker 1:

And then, once you've decided what you want to write calls on, you have to have some operational infrastructure to support that. One is typically there's some sort of margin requirement, so you have to manage your margin, your collaterals, to meet the requirements of whatever broker that you're using. And also many cases derivatives, such as options, have finite life right, so they expire at some point. You either have to roll into it or it's not like owning a stock, where you potentially, if the company is a continued ongoing concern, you can hold it forever, right. But options you have to refresh, you have to. Once the option expires, you have to maybe write another one and, more importantly, actually, if you want to exit the position, you have to buy all the calls back right To unwind the trade. So it's a little bit more complicated than owning a stock. So you have to have an infrastructure around it and traditionally that has not been really scalable for individual advisors. So they've only offered the service to basically the largest of their clients.

Speaker 2:

Are all covered call strategies substantially the same? Clients Are all covered call strategies substantially the same, or is there? Are there some interesting nuances or unique aspects that make you know, maybe one manager using a cover call strategy have better performance, definitely, than another?

Speaker 1:

Yeah, it's. If you're doing a straight traditional cover call strategy, it is all the same. And then I forgot to answer your question. Actually, why is this sort of popular in the current environment? So you know, cover call strategies do not work well in all environments. There are certain environments where it works very well and those are, I would largely put it, in three different categories. One is a slowly upward appreciating environment where the stock is always sort of appreciating but below the strike and we'll talk a little bit more about that of the call. You can generally, if your call expires below the strike, you can harvest the sole premium. The second is if a particular underlying asset is trading sideways. So there's actually in the current market, volatility where it goes up, it goes down, but it's really range bound, so it again doesn't hit the strike of the call that you're writing. And the third environment is where the underlying is actually falling in price and there is sort of a defensive move where when you put a call, the exposure of the long asset plus the call gives you a beta of less than one, and so if you want to hold that asset for a longer time you can clip some income. The beta is less than one. So the volatility actually goes down. In this combination and generally when the asset is falling in price, you're never going to be in the money for the call, so you're clipping the entire full premium of the call. So those are the environments that work really well. The environment that does not work well I always like to manage expectations and give the risks of different strategies is if you have a sudden increase in the price of the underlying asset.

Speaker 1:

Because what happens with doing a cover call? Essentially you're doing two things. You can think about it in two different ways. One, you are harvesting this premia that exists in the market, called the volatility premia. Usually, market are pricing volatility higher than the realized volatility. So the premia you're really really harvesting here is the difference between implied volatility versus realized volatility. So the market is willing to price more volatility than is actually being realized, and so you're harvesting that difference between the two.

Speaker 1:

But the second thing you can think about is, over the long term, you are trading some of the upside of the underlying stock for income, or this premium that you're harvesting. So a cover call strategy is something that I think you need to be a little bit aware of what market environment you're in to use it in your portfolio, and so those environments. In the environment in which the stock goes up very, very fast, what happens is it will go into the strike of the call that you're selling. Your call becomes in the money. So you are limiting some of the upside of the underlying securities that you have in terms of price appreciation.

Speaker 2:

Do you get a sense that more retail investors understand that dynamic in terms of environments that's better for than others? Or are they just looking at straight up yield? It doesn't matter if the market or the equity is still stock keeps moving up, they just want that monthly or weekly income stream.

Speaker 1:

Yeah, what we've seen is there's two different types of investors. One is income focused, so their primary goal is to harvest income and the stability of income. And these tend to be and we don't want to generalize too much, but tend to be people who are a little bit older, towards retirement, who want to. Who, now, you know when Buffett says you know the power of compounding interest, you have to have time to compound, right. So those really benefit younger investors who have capital and let it compound over 20, 30 years. These are investors who are maybe towards the end of their investing career. They're going to retire and what they are focused on is the steadiness of income and meeting their cashflow needs as they go into retirement. They still care, but maybe care less, about full price appreciation. So this is sort of the first category. The second is actually people who want to diversify a little bit.

Speaker 1:

Diversify the risk exposure in the portfolio, right, so everybody can pretty easily get equity risk premia in their portfolio. Duration risk, credit spread risk. But volatility of premium is actually, until the SEC change in 2019, it's actually pretty hard to get that sort of volatility convexia premium that you can get in your portfolio. Generally, in the past people have gotten this convexity premium through mortgages. Mortgages has an inherent short vol premium that's embedded in it. But now you can actually with the rule change in SEC in 2019, you can get this volatility premium from other sectors, and one application of that is through growth stocks.

Speaker 1:

So, in particular, growth stocks do not generate dividends, so as you invest in them earlier in your career, you're writing the price appreciation of these underlying securities.

Speaker 1:

That's great, but as you maybe transition into a more income-focused portfolio, you actually have to start underweighting these securities because they don't distribute dividends and you have to start overweighting, I would say, older sector, traditional sectors of the economy. For those who have been around, you remember energy stocks used to be the largest components of the Dow. People, financial names used to be pretty big components 90s in the Dow, and then, of course, utilities. So financials, energies and utilities are the larger dividend distributors and so they tend to be older parts of the economy. And so you have this perverse asset allocation if you're income-focused in your portfolio, which is, you need to underweight the growth sectors of the economy and overweight the older sector of the economy. So some people the second group of folks is tapping into this volatility premium on technology names to generate some additional income. So they don't have to necessarily underweight the growth part of their portfolio, necessarily underweight the growth part of their portfolio. They can pay some of the price appreciation for income in the portfolio and still participate in some growthy part of the economy.

Speaker 2:

I wonder if you've given thought to, in terms of kind of using these types of strategies in the cycle you're in, if it's better to allocate more towards funds that use cover call strategies when you're in a very expensive market fundamentally right, because I would think right if your price earnings and we'll have the valuation metrics are cheap, there's a lot more upside potential. You don't want to cap it as much by selling the calls, but if you're in a very expensive market and you don't know when it's going to turn, that's probably actually what you want to transition more of your equity exposure towards.

Speaker 1:

Yeah, and then there is an embedded view when you pick a cover call strategies in the optimal environment is that the underlying isn't going to appreciate more than the strike of the call that you're going to write, right?

Speaker 1:

So, again, your cover call is only going to cap your upside if the short call that you're selling becomes in the money. So if I write a call let's say an asset is at $100 and I write a call at $120, you're only capping the upside if the underlying security is going above 120. So that's like a 20 return, right? So I think michael is exactly right. Is that if you are in an environment where things look rich and potentially there's limited upside anyways, uh, you can clip this coupon from, uh, this premia that's on the call. And then, because in your base case is that the underlying would never breach the strike of the call that you write, so that would generally be I would fit into stock is trading sideways or the stock has limited upside, potentially going down or going sideways. So those would be actually ideal scenarios to use covered calls.

Speaker 2:

Does it make sense to have a portion of a portfolio having covered calls or is it more logical to say, okay, I'd rather have the entire equity portion have a covered call overlay, right? So the reason I'm asking that is it seems almost like being, I hate to say, half pregnant, but sort of the idea that if you're going to express a view with covered calls for the yield, because maybe you're a little bit worried about just the pure upside of whatever you're investing in the reference asset, then you might as well go all into that type of an approach, as opposed to blending.

Speaker 1:

Yeah, I mean we always try to think about risk management in general in our portfolio. That's pretty important to us. I mean you know you could defend your portfolios in a few different ways. You can have single name views, right. So there might be names that you think you know it's probably reaching a peak for at least this cycle or this year. Then I think it makes sense to you write cover calls on specific names because that will allow you to generate income, obviously, and then you still have sort of the rest of the portfolio to appreciate unfeathered. If that's your outlook.

Speaker 1:

I think generally you want his income is important. You want some portion of it to generate that risk premium. I actually take that back. As an investor, you're always kind of balancing price return versus income return in the portfolio and so for somebody who's focused in price, I would say less portion of it should be in covered calls, right, you want to make sure you optimize your portfolio to increase to reflect growth, to maybe miss valuation from a value stock to you don't want to cut that upside, but I think if you have clients who are focused on income, one of the things that I think this kind of goes back to our tax efficiency portion is that there are many ways. Now that we're not in a zero rate environment, there's now many ways to generate income for your clients. Obviously, there's very traditional ways Bonds distribute interest Stocks, many of them distribute dividends. Right, you can go whatever flavor high yield, investment grade, even reach distribute income. But I would say you want to diversify that source, because now, with this volatility premium, you have different sources of income that you can diversify.

Speaker 1:

And one of the things to actually maybe consider is that most sources of income is taxed at ordinary income, right. So your paycheck rate that is true for dividends and that's true for interest payments payments With income generated from options you actually have the ability to potentially get taxed. It's taxed at capital gains rate. So with that then, you can then potentially optimize for it being taxed. Short-term capital gains rates is like ordinary income, so it's at the same rate. It's like ordinary income, so it's at the same rate, but if you can hold on to it for a while, you can actually get preferential long-term capital gains tax treatment. That can then potentially minimize tax liability. And then the one other thing that is interesting is that a lot of option income strategies distribute a third type of income which is categorized as return of capital, and these are not immediately taxable. They go to decrease the basis of your security and so if you hold it for more than a year or multiple years, all of the distribution can compound, essentially tax-free, until you sell the security, at which point then hopefully by that time you have long-term capital gains and you get the favorable capital gains tax treatment. So that's one thing.

Speaker 1:

To actually consider how to use this in your portfolio. I think that's what Michael's kind of getting into. Should you have a portion of it? Should you have all of it? I generally think you shouldn't have, and this is me being completely straightforward. You should never have 100% overlay on cover calls, because part of January returns is that you want to participate in market growth, right, and so you don't want to cut that risk premium. I think you can get a diversified basket of risk premium without having to do cover calls on the entire portfolio. But from a diversification of income sources and also selective names in the portfolio, that difference tapping to a different in risk premium is. I think we have some analysis and slides that can show that you could decrease the volatility of your portfolio by tapping into that diversification of volatility premium in your portfolios.

Speaker 2:

But your product suite at Curve got it on a broad average on the cover coal approach and then, obviously, on the single stocks and, yeah, single stock funds with these cover coal strategies have been quite popular. Let's talk through some of the different products. First of all, why did you launch these specific individual stocks as ETFs with this approach? Be specific individual stocks as ETFs with this approach? And then, since you mentioned that word steadiness before, how, generally speaking, how steady do these yield numbers tend?

Speaker 1:

to be over time. Yeah, so we launched Sticks single name first and then we launched a basket that uses cover calls to generate income. The first six we came from a few different approaches. One is we add an investment thesis, which is what I mentioned is that traditionally large growth companies, especially technology companies, do not distribute dividends and so there was no way in which you can get both price appreciation and income return from those stocks. You can make an argument you should just hold it for price because their growth. That's a valid agreement. But there are people who want income right from their growthy part of the portfolio, so we were trying to make that trade off a little bit easier in their portfolios. The second was we were actually kind of a tech approach. We were trying to figure out how we can also solve portfolio operation issues for advisors.

Speaker 1:

Again I mentioned, traditionally this has only been really offered to high net worth individuals because it's very intensive, and so when we talked to more independent RAs or smaller RAs or smaller team, they wanted to tap into the same risk exposure but they wanted to have an easy process for doing it. So the single names this essentially allows an advisor to pick the view on these individual names or a basket of them. If they want the exposure, they just enter it, clip the coupons and, more importantly, if they want to exit it they can just sell a share instead of unwinding all of the stuff. And then we sort of curve to manage all of the collateral management, the margin management et cetera in the fund. And then there's a third component. When we thought about it we did six because we sort of wanted this a la carte menu. Some of our advisors whom we work with they have this around either 7% to 9% of distribution that they need to meet for their clients Right now short rates at four and a quarter. So it's very easy to get that four and a half, four, four and a quarter, but there's still sort of this three, 4% deficit. So they would buy different proportions of this in a basket and to become essentially the technology income sleeve to make up that 3% deficit.

Speaker 1:

In terms of distribution, we pick the names also carefully because the amount of distribution generally is proportionate to the volatility of the underlying and, as we know, tech stocks generally are more volatile. So we are able to extract additional yields than, say, a utility company et cetera, if we had written cover calls on it. So these names generally range between 14, 15% to up to 25, 30% in terms of yield. So you just need a little bit of it to meet that 3% yield deficit. And then it turned out some people really appreciated the a la carte approach and some people just don't even want to think about it. They said why don't you guys pick the names? And that's how we launched KQQQ. It was okay, we'll pick the names to generate the yield and also try to keep the upside appreciation, so that one we try to, when the market is up, try to magnify the upside appreciation. When the market is down, we'll try to generate income to mitigate downside.

Speaker 2:

Yeah, it's interesting to see these kind of numbers. As you know, some other fund families have much larger yield, but of course there's an issue with that, which is it can cause some real NAV erosion. Is there, in your view or in your research, sort of a sweet spot in terms of how high yields should go for individual stocks without really taking too much away from the upside?

Speaker 1:

Yeah, and forgive me, I forgot. You asked the question and it's like how do you write cover calls? Are they all the same, okay? So if you're doing a straight cover call strategy, it should be all the same. And there's really three levers. A manager can three dials. A manager can turn to make decisions. Okay, the first is the strike of the call. That's the first dial. The second is how long do you write the option? And then the third is how much calls do you write? Right, those three dials.

Speaker 1:

If you understand it, you can understand any cover call strategy. So the first is the strike and the reason why they're called dials is because they're trade-offs that you have to make as a manager to manage the cover calls that's in your portfolio. I'll go through each one of these because I think there's been so many cover call ETFs in the market and I think that it helps people evaluate what each ETF is doing and whether you agree with their philosophy or not. The first is the strike. So the trade-off is the strike is basically, let's say, a stock is at $100. The strike of the call is when it becomes in the money. When is it out the money? So if the stock is at $100 and you write a call where the strike is at $100, it's in the money, right. If it goes up $1, it's going to be $1 in the money, right. So the trade-off is the closer you write the strike to the price of the underlying spot, generally, the more premium you're going to be able to harvest. But the trade-off is the closer you write it to the spot, the more upside you're going to get. Let me give you an example. If the stock is at $100 and my strike is at $110, so you are setting the price appreciation at 10%, the stock can appreciate to $110 before it caps out by the call, you get more premium at $110 than if you write a call that has a strike at 120, right. 120 is further out in the money. You get less premium. But your trade-off is that the stock can appreciate 20% before it's capped out by the call option right. So as a manager, you have to decide what is the strike For us at Curve we tend to write jargon is about 30 delta calls. So, depending on the volatility, it's either 5% or 15% out of the money. And the reason why we like to do that is that for the names that we write are tech stocks. We know that many people still want some price appreciation on these tech stocks, so we want to be able to have a room for the stock to appreciate while we clip a good amount of coupons. So that's where we feel like the sweet spot is.

Speaker 1:

The second dial is the maturity, the tenure of the option. Maturity, the tenure of the option. Now options you can write zero day delta. You can write an option that expires today. You can write weekly options, you can write monthly options and you can actually even write a year option out. Again, there's a trade-off. The shorter the maturity of the options, the more you can write them and potentially you can clip more premiums right the longer like, for instance, a year option you can only write one every year. So your yield is set by that one single option.

Speaker 1:

And the way I think about this is sort of coin flips. If you're writing at the money, if you write it at the money fall, it's a 50% ends up in the money or 50% that's out of them. So if you're writing a weekly option, every year you have 52 chances to write that option and if you flip your coin you might win some, you might lose some. But if you're nerdy, if you calculate the probability at that, 0.5 to 52 power, that's a very low number. That's a possibility of you winning every single coin. Toss is very low Versus if you do, your odds improve to be right if you write a monthly, because then it's 0.5 to the 12% right and then versus yearly is 1 to you know, the 0.5 to our 1, right. So your probability increases as the longer but you have less coupon right. So that's the trade-off a manager has to make. So at Curve we generally write.

Speaker 1:

We think the sweet spot is about a six-week expiry of options, but we roll it on a monthly basis and the reason is that we generally take advantage of this particular aspect of options which is called theta. It is basically time decay. That's in the option. It's like a bond. When you write an option, the one thing that is working for you always, always when you're short of option, is time as the expiry. When you sell a call, you get a premium right and as it gets to expiry you are harvesting more and more of the premium. The value of the option goes to zero. So your liability of the option you get to clip the full coupon. So that's the one thing that we always are always option investors friend, which is like time, so we want to maximize that.

Speaker 1:

So we think a monthly role of our options is a sweet spot.

Speaker 1:

And there's another reason, which is that generally when the underlying as volatility right, it may go into in the money, right.

Speaker 1:

But the cycle for many of these names that we write is that they generally mean revert within a month. So if they have you remember I mentioned that the one environment that's really not great is if you have a sudden increase in price appreciation and you hit the strike and you're in the money of the call right, then you tap your upside. But what happens is if the stock goes up a lot and it comes back down, as long as it expires out of the money, you get the full premium right. So when you're writing weekly calls, many times you're actually getting hit on the upside of the call and then you write another call, you cap your upside and you write another call when it comes back down you don't fully get the premium that you get for the call that you write. We think a good mean reversion cycle for many of the names that we have is about a month. So that's the sweet spot and the last dial. I'm going a bit long so I'm going to shorten it, no, no, but this is good.

Speaker 2:

I like the way you're communicating this, because there's so much more nuance behind the scenes than most people realize. They just look at a yield number or they look at the underlying reference asset, but there's so many nuances that make it really important to sort of understand it.

Speaker 1:

And the last aisle is just how many calls? So let's say you have $100 worth of stock, you can write $50 worth of call. So that means that 50% of the security can still increase in price unfettered. And let's say you hit the strike on the other $50, only 50% of it is capped, right? So a manager can decide do I for $100 stock? Do I want to write $25 worth of calls, $50 or $100 worth of that? And who can adjust? So at the end of the day, that's the last dial.

Speaker 1:

Again, the trade-off is the less calls that you write, the less premium you get. But there's also more price appreciation potential. The more calls you write, the more premiums you get. But potentially you cap more of your upside if the stock goes up in price very quickly, right? So these three dials are the things that you as a manager have to make a decision on. So, for instance, in the KQQQ, the basket ETF that we have, we step into things. If stocks don't have price momentum, which is sort of trading sideways or going down, we step into it. We start with zero, we write 50% cover calls and if it continues to not have price momentum, then we write 100% of notional so you can adjust that dial so that you can maximize the risk you're taking for the premium that you're harvesting in the cover call.

Speaker 2:

Let's take a step out from the weeds around cover calls for a bit, because markets have been acting, at least as we're chatting here. You know February 25th a little bit more volatile than usual, yeah, and when you're in changing vol regimes, assuming the volatility lasts for more than a couple of days, obviously right that it's not just the whack-a-mole that happens with these VIX spikes and it comes right back down. Talk to me about what happens at curveve meaning. Is there more activity? Are there changes to types of options that are being sold?

Speaker 1:

Give me some behind-the-scenes insight not a lot of changes actually. So we're fairly systematic. So typically when we roll on a monthly basis, we're pretty systematic. There's a two or three day window in which we roll and again, as I mentioned, we generally look at the 30 Delta call and because we write longer monthly calls, we're watching that data decay. So even short-term volatility doesn't affect us a lot.

Speaker 1:

And I think you don't want to react to the market right, you want to anticipate the market. And then the reason why I keep saying it's a volatility of risk premia is because this premia is a persistent mispricing of volatility in the market and we want to get that consistent mispricing Short-term news that pops up the market oftentimes. You could be lucky that I would put in more in the bucket of luck, you could benefit from it, but it's maybe a one-time, it's persistent. So we want to capture that persistent risk premium. The one thing that we do do something out of our normal cycle is actually during earnings. Even that is a bit systematic, which is that generally implied vol for many of these names. Generally implied vol for many of these names, even non-tech names, implied vol for these names.

Speaker 1:

Spikes before earnings calls. Earnings announcements. We will time it so that we can write the call where volatility potentially is maximum and then generally volatility implied fall falls after earnings. So when you're shortfall, that is a benefit to your portfolio. So we make sure that we take that into consideration, especially during earnings season. So that's four times a year and the other eight times were pretty persistent and systematic in terms of how we harvest the volatility premium.

Speaker 2:

Have you seen, in terms of the types of prospects that you talk to and investors using Curve's products? Do they tend to lean towards a particular specific funds, the other individual or the KQQQ, and what's sort of been the source of interest?

Speaker 1:

Yeah, I think the asset location use is different. So the folks who have income-focused clients, they generally buy three or four names in the portfolio. It tends to be barbell actually. For those who want to clip a nice coupon but want to as a portion of diversification of their incomes, they generally pick the single names. That's more stable, like, well, google or Microsoft, right, these are pretty stable national champions. They're definitely not going out of the business tomorrow or in the next five years and they're just clipping coupons just like a bond. But instead of some bond risk they're getting from an equity risk. So it's a diversified exposure in the portfolio.

Speaker 1:

There are other advisors who do have a view of particular names, like Netflix. That particular fund or the premium that you can generate is around 25% and then, underlying that, the underlying stock has gone up, I think the fund's like 35%. So they want both this double punch of price appreciation and income return. They pick single names. So those are kind of the usage for that. They have a very strong view on some of these particular techniques. And then the last is just people don't want to have a, they don't have a specific view and they want, you know, an income generating triple Q exposure in their portfolio. So then they use it as part of their overall asset allocation.

Speaker 1:

They have bonds, 60, 40 portfolios, and then this is K-triple Q sort of the technology sector. And the other thesis for K-triple Q that people have really clung on to is that we have had a persistent question always whether the technology sector is overpriced. When should we rotate out of it? And oftentimes with technology stocks you hold it for a long time. You have really low basis. Allocating out of that strategic exposure is usually pretty expensive from a tax perspective. So they just want an exposure that can manage the cycles in tech, and that's what we're trying to do in KQQQ. And so they use it as a, you know, a QQQ replacement substitute or even a portion of S&P replacement, because it has good yield and it can mitigate downsides with income. So, given all this talk about, you know, technology being a large part component of US equity, they want a defensive exposure in their portfolio.

Speaker 2:

Talk to me about options liquidity. Obviously, these are huge companies and the options markets are huge, but you know, is there a point where which is a good problem to have where one of the funds really blows up an AUM and the actual execution of the cover call strategy gets challenged.

Speaker 1:

No, I think for us we also maybe an ancillary reason we picked these names because they are it's been written ad nauseum some of the largest components of the US equity market and that's reflective in the liquidity of their option market as well. We don't, you know, I think, if we were writing in some small stock that there might be a liquidity issues. But we don't. In normal market environment and also in stress environments which we've seen over the last two months and in 2024, the bid-ask has been pretty tight. So I think liquidity concerns not as great in these particular names.

Speaker 2:

You mentioned that it's not easy for people to do this themselves, so better to outsource it to a company that's focused on this curve, but that's not going to stop people from trying to do it themselves, right Is there? You mentioned being systematic. I'm sure there are plenty of people that do this not in a systematic way. Talk to me about sort of the challenges of those implementing it themselves, using a more discretionary type of mindset when it comes to cover call strategies. And why is it that systematic is better?

Speaker 1:

Just for the DIY folks. I mean, if you know your portfolio the best, you executing cover calls has a certain attention and focus on it. So I don't ever want to discount that. But I will say the biggest difference comparison is in the pricing. We took a look at what the bid ask of options in retail platforms the last time we checked it's almost 10 times than sort of an institutional bid-ask that we can get. So you know, from an execution standpoint, outside of complexity of like rolling the calls, doing the collateral management, the margin maintenance et cetera, there is a difference in pricing. So depending on how big of your portfolio, how many times you want to roll those transaction costs can actually eat into quite a bit into returns. So that's something to watch out for A lot of the retail platforms. Part of why they're in it is that generally retail bid assets are wider and we think because we get institutional pricing, we aggregate assets, we can get good execution, better execution than most in our portfolios. You've got several uh, several funds.

Speaker 2:

It sounds to me like you're planning on launching some others, because that's what companies do, right Keep on putting out interesting products, you know, and go where the demand is. Um, I am curious when you go about thinking about launching new funds, what's? What's the process meaning? How are you trying to determine this or that stock Meaning? How are you trying to determine this or that stock?

Speaker 1:

You know it's something on a single stock side. We should maybe launch a cover call strategy on. Yeah, I mean, I live in San Francisco, so there's a lot of tech people here. But no matter what you think about tech companies, the one thing they are very good at is they try to look for a need and then try to find a solution to it, and it doesn't just have to be in the technology sense. It could be from an investment sense.

Speaker 1:

We do talk to a lot of the advisors that we work with to see what is both operational needs, challenges, exposure needs, what do they have they want in their portfolios that they don't have already in their portfolios? And then we go from there. And now that we have more and more clients, the nice part about that is that there's a feedback loop. They will let us know what they want to see in their portfolio. So those are generally the seed of a new product. But then there's other parts where it's more portfolio management. Maybe we see something very persistently mispriced in a strategy that we think will be there for the next three to five years. That can also be a reason for us to launch a new fund, a new strategy.

Speaker 2:

Yeah, that makes a lot of sense. As we wrap up here, Howard, for those who want to learn more about Curve, where would you point them to and maybe give some, you know, kind of like a closing pitch on why investors should consider some of your funds?

Speaker 1:

Yeah, I think you know Curve is started. As you know, our mission is to provide access to these tax efficient institutional strategies and now we're going into also tax deferred solutions. But we come from a very institutional background from a very institutional background and so we manage our strategies, I think, with a certain ease and fiduciary for the net assets in the investors for the fund, I think maybe very uniquely than maybe other managers that are in the market. It was briefly mentioned that one of the problems with high distributing funds you have this problem with NAV erosion and we could have gone the route of advertising the highest yield, making us a little bit snazzy. We are not snazzy, we just know we have experience knowing what will work in the market and so we tend to apply that philosophy into all of our strategies that we know there's certain risk premium that can be harvested in the market.

Speaker 1:

We want to be consistent. We're not the flashiest with the highest yield. We know what could potentially erode investors' capital and we want to do everything we can to prevent that. So we want to be a good steward for your capital and, of course, we're really open to basically feedback from investors. We have several different channels on our website, a form you can complete. We hear what people's needs and the way that we have arrived at what the ETFs now is actually a little bit of a departure or a slightly different or improvement from when we first launched, just because we continuously take this tech approach of improving what the clients need. So that's what we can promise and offer at Curve and so, if you take a look, we're also extremely transparent with our strategies. So if you have questions, please don't feel free to ask and, outside of compliance issues, we'll try to provide as much answers as we can, and that's what we're here for to help you build a good relationship and reach investment objectives for your clients.

Speaker 2:

Again, folks, I hope you enjoyed this conversation. A lot of really interesting nuggets, I think, from what Howard was saying. As far as nuances around cover call strategies, Make sure you learn more about Curve's various funds. Again, this is a sponsored podcast conversation and I'll be doing more of these conversations with Howard Chan and his team. Thank you, Howard, Appreciate it. Thank you, Michael. Cheers everybody.

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Michael A. Gayed, CFA

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