How to Create Corporate Bond with Covered Call Strategy?

A covered call position act like a corporate bond. Both give limited upside gains but also some downside protection. So I would like to explore if I can build a corporate bond position with stocks and the covered call strategy.

Face Value

Face value of an option is the first thing I am concerned. Although there is no real face value in the covered call positions, we still need to know how many stocks are covered by a short call contract.

An option contract covers 100 shares of stock, so if I want to build a covered call position, I need to buy 100 shares of SPY for $373 with a total of $373*100 = $37,300.

Already crazy. If I do a covered call once and the call option gets executed, I will have to sell stocks worth of about $37,300. How many times do I get to do this if I am not so rich?

The mini-option of XSP, though a smaller contract size than SPX, still has this problem of one contract requires a lot of money for the underlying assets. XSP prices at 373 still means 100 units, so it is still $373*100 = $37,300.

Coupon Rate

Let's simulate the coupons I earn with a covered call position. 

The above price is obtain on the day I write this article which is June 15, 2022. I chose the option expiration date to be July 15, because I want to simulate monthly coupon of a bond. We can see the price of the option is $10.66. The latest SPY price is $375.63. 

I will have to buy 1 share of SPY for $375.63, sell a call option and earn $10.66, 10.66 divided by 375.63 is 2.838% which is multiplied by 12 to be turned into annual yield of 34.055%, which is very high.

Taking into account the spot price for SPY is $375.63 and if SPY price reaches higher than 376 which is the strike price, I make $376 - $375.63 = $0.37. So I will also make an additional $0.37 besides the money I earned from selling the call option which is $10.66.

Then I would make a total of $0.37 + $10.66 = $11.03. $11.03 divided by the total money I spent on SPY, $375.63 and times 12, I have got 35.237%, which is still high in terms of being a bond. LQD has a yield of about 2.63% the same day I am writing this article. 35.237% / 2.63% = 13..698 which is like saying construct 1 contract of this coverer call is similar of buying a corporate bond with a face value of $37,563, a coupon rate of 2.63% and a duration of 13.698 years. By the same, discount for all a real bond's coupons are not taken into accounts here. If so, the covered call position would have even higher yield.

Further Thinking

There are many ways to price an option, no-arbitrage pricing model or the Black-Scholes-Merton Model. But if I compare the call option price and potential money I get from execution of the covered call position with corporate bonds, both in terms of yield with a initial investment as the face value, I can know if the call option is cheap or expensive.

In the example above, the yield I get from the covered call position is much higher  than the yield of LQD, which could imply the call option is expensive. I should not buy the option, but construct a covered call position.

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Stock Spot Price: $
Call Price: $
Call Strike Price: $

Why is covered call imply this much earnings?

In the example above shows the potential covered call income yield is 35.237%, which is quite high. The reason of it being so high may be the fact that a covered call position has no downside risk protection. In contrast, a bond has. 

Add a Put

In order to simulate a corporate bond position better, we should add a put option contract to the covered call position, so that lost is limited.

The time I write this paragraph, the SPY spot price is $381.74. 

Using the data above, I want to calculate the gain and lost of a covered call position with a put option. The put option with a strike price of $372 is the highest strike price I have found that is cheaper than the call option premium,

Selling a call for $9.7 and buying a put for $9.43, I get $9.7-$9.43= $0.27. $0.27 divided by $381.74, the SPY spot price, I get 0.071% which after being timed by 12 is 0.848%.

If SPY price reaches over 382, the covered call is executed and earns another $382-$381.74=$0.26. $0.26+$0.27= $0.53, $0.53/$381.74 = 0.139% which gets timed by 12 is 1.666%.

If SPY drops lower than $372, the loss is $381.74 - $372 = $9.72, which should be compensated by options premium we got in the beginning of this trade. $9.72 - $0.27 = $9.45. $9.45 / $381.74 = 2.48%.

In conclusion, this position is similar to a bond position of  a yield of 1.666% with maximum loss of 2.48%.

Calculator

When should I Add A Put Option to A Covered Call Position?

I don't think you should add a put option to a covered call position. The mentality is when building a covered call position, you want to hold the underlying stock anyway and you free it is alright to sell them, too. Adding a put option means you can also sell them when the stock price drops, which does not fit the buy long mentality.

Stock Spot Price: $
Call Price: $
Call Strike Price: $
Put Price: $
Put Strike Price: $