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A call option on a stock gives the buyer the right to buy 100 shares of stock at a fixed price up to a specific future date in exchange for an upfront payment. The fixed price is referred to as the strike price, the future date is referred to as the expiry date and the upfront payment is referred to as the premium. Effectively, the buyer pays the premium upfront and acquires the right to a stock’s future price appreciation above the strike price. The seller, on the other hand, gives up the right to the stock’s future price appreciation above the strike price in exchange for upfront premium payment as income.

A covered call strategy is a strategy in which an investor owns (or “holds a long position in”) a stock and sells (or “writes”) call options on that same stock. By selling the call options, the seller gives up the right to the stock’s future price appreciation over the strike price and receives an upfront premium payment as compensation. The covered call strategy gives the seller the unique ability to convert a stock’s uncertain future returns into certain upfront premium income.

Investors who sell covered calls typically execute continuously rolling covered call strategies (i.e., when the sold call option expires, they sell a new call option). For example, the investor may sell a call option on a stock with one month to expiry against a long position on the stock. The investor collects the premium income and gives up future upside. One month later, when the call option expires, the investor will sell a new call option with one month to expiry and collect premium income again. This process repeats on a rolling basis. A covered call strategy is also known as a "buy-write strategy" or may be referred to as a “call option selling strategy.

First, let’s define a fully covered call selling strategy as one in which the investor sells calls against the entire long position on the stock. (Put another way, he/she sells calls on every share of stock he/she owns). This means the investor gives up future price appreciation of the stock above the call strike price in return for the upfront premium.

In contrast, a partial call selling strategy is one in which an investor sells calls on a smaller percentage of each stock holding. A partial call selling strategy would collect a lower level of premium income but would also give up only a portion of the future returns. A partial call selling strategy allows an investor to strike the appropriate balance between the upfront predictable premium income collected and the future returns given away.

As an illustration, let’s say an investor holds 1,000 shares of XYZ stock. A 10% call selling strategy (or 10% “overwrite”) means that the investor sells calls on only 100 of the 1,000 shares. He/she collects premiums in return for selling calls on 100 shares, and gives up the future upside on those 100 shares if, in the future, the price rises above the strike price. He/she retains the future potential appreciation on 900 shares.

Target Income strategies prefer to sell calls at-the-money (ATM) to maximize the call premiums while minimizing the percentage of securities that need to be covered.

Target Income strategies prefer to sell short-term options, like weekly or monthly, to generate greater income. There are two key factors that investors should recognize about short-term options as compared to longer-term options. First, there are more opportunities for the investor to give up potential upside for short-term options. Second, the risk that the option is exercised is moderated somewhat by the fact that a move above the strike price is less likely within a shorter period.

While the Target Income Strategy design utilizes a rules-based framework, there is complexity and discretion required to actively manage the strategy. The strategy involves rolling a large number of options contracts over a short period of time and managing the assignment of a significant number of options. Vest has a track record of managing the strategy since 2017 and has developed the requisite options trading capabilities and expertise.

The strategy, when deployed as a Fund in investor accounts, delivers the expertise of the manager in a productive manner compared to a direct implementation. The illustration below depicts the magnitude of option trades per year to implement a simple version of the strategy on a single asset for 100 accounts.