Soochow Journal of Economics and Business

No.84 (March 2014)25-46.

Empirical Performance of Covered-Call Strategy under

Stochastic Volatility in Taiwan
Chang-Chieh Hsieh*

Chung-Gee Lin**

Max Chen***

Abstract
This study examines the performances of conventional strategy and dynamic coveredcall strategies, including constant and stochastic volatilities environments in Taiwan. In accordance with prior literatures, the covered-call strategy may roughly boost portfolio return
in some specific moneyness. The monthly return of the conventional covered-call strategy
is slightly more than the pure futures buy-and-hold strategy on the average. The dynamic
strategies adjust the moneyness based on different exercise probabilities under constant volatility and stochastic volatility. Finally, this study points out that the advantage of the dynamic strategy under stochastic volatility is more obvious than constant volatility or conventional strategy.
Keywords: covered-call, dynamic strategy, moneyness, stochastic volatility.

Corrseponding Author: Chang-Chieh Hsieh is a Ph.D. candidate in the Department of Economics,

Soochow University, Taiwan.
** Chung-Gee Lin is a Professor of Finance in the Department of Financial Engineering and Actuarial
Mathematics, Soochow University, Taiwan.
***Max Chen is an Assistant Professor in the Department of Finance, Ming Chuan University, Taiwan.
*

1. INTRODUCTION
The Black-Scholes is the most popular option pricing model in the world; however,
there are still some shortcomings. The previous research pointed out the case that the option
price is lower than the Black-Scholes price when stock price is quite close to exercise price,
and that the option price is higher than the Black-Scholes price when stock price is deeply
in or out of the money. Hence, we can expect that the price bias will be more severe in a
highly fluctuant market, such as emerging markets.
The emerging market, Taiwan, grew rapidly, especially in the futures market. The Taiwan Futures Exchange (TAIFEX) was established in 1998. After years of hard work, the
exchange is one of the fastest growing options market in the world (see Figure 1). TAIFEX
options volume is ranked the sixth greatest market around the world in 2010 according to

Transaction of Billions

the report of the World Federation of Exchanges (WFE).

Volume Trades (Number of Contracts)

100
90
80
70
60
50
40
30
20
10
0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Year

Figure 1 TAIFEX options historical volumes during 2001 to 2010, according to the record
from the World Federation of Exchanges (WFE).

It is more reasonable to consider stochastic volatility instantaneously embedded in pricing option. However, past researches about establishing a portfolio containing assets and
options almost did not consider the volatility disturbance. This paper is devoted to adoption
of the stochastic volatility model, the Heston model (1993). In addition, we also compare
Heston models performance with the Black-Scholes models, and expect to get more precise forecasting option prices in TAIFEX.
Covered-call (buy-write) option trading strategy, which is the portfolio combined by
one unit of the long underlying assets with writing one call option, has been being studied
in previous literatures and being assessed its performance. This trading strategy is the
simplest concept extended from the Capital Asset Pricing Model (CAPM) which is used to
hold negative correlation between asset and derivative to improve returns and to reduce risks. The trading strategy holders receive a premium when they sell a call option; in the meantime, the premium can reduce the cost of a single long position of the underlying asset. The
premium amount depends on the extension of the OTM (out-of-money) conditions. The trading strategy holders will receive the more premium as the option exercise price is closer to
current underlying asset. Another important factor is the underlying assets volatility, which
represents the fluctuated degree of the underlying asset. Therefore, choosing the appropriate
moneyness is a key to the performance of building a covered-call portfolio. Che and Fung
(2011) used the conventional buy-write (covered-call) strategy and a dynamic buy-write
strategy to test the performance on Hang Seng Index (HSI) in Hong Kong. Che and Fung
(2011) adopted HSI futures to substitute HSI in order to reduce the impact of transactional
cost and execution problems. They found that both strategies outperform the naked futures
position. Although the dynamic strategy uses various risk-adjusted measures, which usually
have lower returns than the conventional fixed strike strategy, the dynamic strategy outperforms the fixed strategy when the market is moderately volatile or being in a sharply rising
market.
Figelman (2008) introduces a simple theoretical framework which allows decomposing the observed historical performance of covered-call strategy into three market components: risk-free rate, equity risk premium, and implied-realized volatility spread. Figelman
(2008) pointed out that the covered-call strategy is highly correlated with the equity market

index (S&P 500), especially in the bull market. Hill et al. (2006), Feldman and Dhruv (2004)
and Whaley (2002) also investigated the covered-call strategies on the S&P500. They did
not obtain strong evidence to explain that covered-call strategies provided better performance than naked futures position. Nevertheless, they concluded that covered-call strategies
can effectively reduce risks (standard derivation).
This study extends the works of Che and Fund (2011) and Figelman (2008) to investigate the performance of covered-call strategy in TAIFEX. We divided the market into different situations (rising (bullish) or falling (bearish); sharply or moderately, refer to Figure
2), and examines the performances of conventional strategy and dynamic covered-call strategies including constant and stochastic volatilities environments in Taiwan.

Figure 2 TAIFEX Future for the period Feb-2004 to Nov-2011. Periods 14 and 8 represent
sharply falling. Periods 35 and 7 represent sharply rising. Period 2 represents moderately
rising, and the rest represents moderately falling.
The rest of this paper is organized as followed. In Section 2, the covered-call option
trading strategies, the constant volatility and stochastic volatility futures option pricing

models, were introduced. Section 3 describes the data and defines four different market situations. The last section is the conclusion.

2. THE MODEL
Covered-call trading strategy, in this paper, is built as to buy index futures and simultaneously sell short European calls. Therefore, the volatility of the underlying futures and
option exercise price will affect the performance of the covered-call trading strategy. When
the volatility of the underlying futures increases, the income from the short sale from the call
options will increase. As the option is close to ATM (at the money) condition, the income
rises.
Building the covered-call strategy involves a position of short sale from futures call
options, resulting in involving the option pricing models. We first assume the volatility of
underlying futures is constant, in accordance with the Black (1976) model, shown in equation 1, which will be used for constructing the short sale from a call option position.
c = F0 N (d1 ) XN (d 2 )
d1 = (ln( F0 / X ) + 2T / 2) / T , d 2 = (ln( F0 / X ) 2T / 2) / T . F0 is the price of under-

lying futures; X is the exercise price; T is the time to maturity at years. c and p represent call
and put options1.
Under the stochastic volatility environment, the Heston (1993) model, shown in equations 2 to 4, will be used for constructing the short sale from a call option position.
1
dxt = r vt dt + vt dz1,t
2

dvt = k [ vt ] dt + vt dz2,t

c = F0 P1 XP2

where is the long-run mean of the variance. k is a mean reversion parameter.

is the vol-

atility of volatility. x is ln (F). F is future price. X is the exercise price of call option. r is risk-

free interest rate. v is volatility. The quantities P1 and P2 are the probabilities that will be
exercised by the call option, conditional on the log of the last future price, x T ln FT , and
on the last volatility v T. The risk-neutral dynamics was expressed as equations 2 and 3. z1 and
z2 are Weiner process. The rest details are provided in Appendix A.
The return from a covered-call is derived as below,
Return =

FS F0 C ( X ) Max ( FS X , 0 )
+

F0
F0
F0

where FS is the last settlement price.

In this study, the selected exercise price is divided into (1) the fixed ratio model and
(2) the dynamic adjustment model. The rewards of fixed ratio models consist of a traditional
fixed exercise price and futures price in the beginning of the period. Exercise price is studied
for the degree of difference from 1% to 6% OTM during four specific ranges.
In Figure 3, we can see a clear change of the price of the option premium. Dynamic adjustment model exhibits constructive dynamic parts of the fixed compliance probability; this
study, in addition to the construction of Black's (1976) futures option pricing model for the
fixed compliance probability and volatility, is back stepping specific exercise price.
Then, we follow the same seven distinct probabilities of compliance cases which were
set in the Che and Funds (2011) research. The results of different moneyness trends were
shown in Figure 4.
This study also extends the Heston stochastic volatility model (1993) with the optimization techniques for deriving the in-the-money probability P2. The moneyness trends were
shown in Figure 5.
Call options are used as the short position in Taiwan index options (TXO). In this study,
the process is to sell the option contracts in the past month and hold to maturity. According
to the model of Che and Fung (2011), to reduce the problems of dividend, hedging, transaction costs and non-synchronous trading, we use Taiwans stock market futures (TX) to replace the Taiwan Stock Index2.

Figure 3 Call premium (as a percentage of futures) for the period Feb-2004 to Nov-2011.

Figure 4 Moneyness of the dynamic portfolios and implied volatility under the Black model
for the period Feb-2004 to Nov-2011.

Figure 5 Moneyness of the dynamic portfolios under the Heston model for the period
Feb-2004 to Nov-2011.

3. EMPIRICAL TESTS
3.1 Under All Period Market Conditions
According to the models, the fixed implementation price strategy, dynamic adjustment
strategy in compliance probability, risk values and descriptive statistics were shown in Tables 1 to 3. From Feb-2004 to Jan-2012, the monthly average return for simply buy-and-hold
strategy is 0.32%.
In the covered-call strategies, as the moneyness is more deeply OTM, the short position
of call will receive fewer premiums. Generally, the short position of 3 to 6% OTM call options will increase the monthly total return. The risk will be smaller than the naked futures
position. Finally, whether we use the Sharpe Ratio or Sortino Ratio as the performance indicators, the short position of 6% OTM call option can get the best performance significantly enhance return, and reduce the risk.

Table 1 Overall monthly performance of different fixed moneyness for the period
Feb-2004 to Jan-2012.
Pure Future

1%
OTM

2%
OTM

3%
OTM

4%
OTM

5%
OTM

6%
OTM

Covered-Call Return

0.32%

0.19%

0.25%

0.34%

0.37%

0.40%

0.43%

Covered-Call SD

6.75%

4.62%

4.89%

5.20%

5.48%

5.72%

5.91%

2.09%

1.71%

1.35%

1.09%

0.86%

0.69%

Moneyness

Call Premium Return

Coefficient of Variation, CV

20.93

23.75

19.48

15.31

14.94

14.27

13.69

Median

0.98%

2.09%

2.38%

2.05%

2.05%

1.66%

1.39%

Max

15.65%

5.98%

5.98%

7.30%

7.34%

8.77%

8.91%

Min

-18.72%

-17.43% -17.79% -18.07% -18.07% -18.29% -18.42%

Semi-SD

4.53%

5.13%

5.77%

6.52%

7.30%

8.12%

8.95%

Sharpe Ratio

4.78%

4.21%

5.13%

6.53%

6.69%

7.01%

7.30%

Sortino Ratio

7.12%

3.80%

4.35%

5.21%

5.02%

4.94%

4.82%

Table 2 and Table 3 show the results of dynamic adjustment covered-call respectively
under Black (1976) model and under the Heston (1993) model. Both implied volatilities are
calculated by using all day-end information excluding the volume under 100 contracts. In
Heston model, we use the method of exhaustion to obtain the optimal parameters in given
lower bound [0.01, 0.01, -1, 0.01, and 0.01] and upper bound [0.6, 0.6, 1, 5, and 0.6]. (Represent the volatility of variance, current variance, rho, kappa, and the long-run mean of the
variance respectively.)
In the Black (1976) model, the rewards in all seven compliance probabilities from 17
to 49% are less than the naked futures position. However, there is still an advantage to
choose the exercised probability around 30% in order to reduce the fluctuation from return.
Heston (1993) model significantly improves the performance of the remuneration. Apparently, the dynamic covered-call strategies under Black (1976) perform less than the naked
futures position. The Heston (1993) model is highly closer to the actual cases than the Black
(1976) model.

Table 2 Overall monthly performances of different exercise probabilities under the Black
model for the period Feb-2004 to Jan-2012.
N(d2)

49%

42%

36%

30%

25%

20%

17%

Covered-Call Return

0.13%

0.16%

0.23%

0.30%

0.24%

0.27%

0.25%

Covered-Call SD

4.23%

4.68%

5.06%

5.46%

5.68%

5.92%

6.06%

Call Premium Return

2.65%

2.05%

1.64%

1.23%

0.97%

0.71%

0.56%

Coefficient of Variation, CV

32.62

28.78

21.83

18.10

23.83

22.13

24.60

Median

1.70%

2.06%

2.05%

2.05%

1.95%

1.95%

1.55%

Max

5.25%

5.98%

8.77%

10.39%

11.31%

10.49%

10.49%

Min

-16.95% -17.43% -17.79% -18.07% -18.29% -18.42% -18.42%

Semi-SD

8.14%

7.89%

7.51%

6.96%

6.18%

5.18%

3.73%

Sharpe Ratio

3.07%

3.47%

4.58%

5.52%

4.20%

4.52%

4.07%

Sortino Ratio

1.59%

2.06%

3.09%

4.33%

3.86%

5.16%

6.60%

Table 3 Overall monthly performances of different exercise probabilities under the

Heston model within the period from Feb-2004 to Jan-2012.
N(d2)

49%

42%

36%

30%

25%

20%

17%

Covered-Call Return

0.26%

0.31%

0.39%

0.35%

0.39%

0.44%

0.40%

Covered-Call SD

4.61%

4.94%

5.31%

5.57%

5.85%

6.10%

6.18%

Call Premium Return

2.20%

1.73%

1.38%

1.09%

0.82%

0.63%

0.53%

Coefficient of Variation, CV

17.91

16.19

13.76

15.71

15.10

14.02

15.38

Median

2.11%

2.34%

2.05%

2.05%

1.66%

1.55%

1.39%

Max

5.98%

7.30%

8.70%

9.79%

10.63%

12.35%

12.15%

Min

-17.43% -17.79% -18.07% -18.07% -18.29% -18.29% -18.42%

Semi-SD

8.37%

8.07%

7.64%

7.08%

6.31%

5.28%

3.78%

Sharpe Ratio

5.58%

6.18%

7.27%

6.36%

6.62%

7.13%

6.50%

Sortino Ratio

3.07%

3.78%

5.05%

5.01%

6.14%

8.25%

10.62%

As shown in figure 6, we use the simple tradeoff between return and standard derivation to compare with the naked future position, conventional covered-call and dynamic
covered-call strategies. Obviously, the left upper quadrant based on the pure future outperforms the other quadrants. In conclusion, the conventional covered-call and dynamic covered-call under Heston model have more risk than the naked future position in the same return

level.

0.45%
0.40%

Return

0.35%
0.30%

Future

0.25%

Fixed Strike
Dynamic (BS)

0.20%

Dynamic (Heston)

0.15%
0.10%
4.00% 4.50% 5.00% 5.50% 6.00% 6.50% 7.00%
SD

Figure 6 The tradeoff between return and SD for pure future, conventional covered-call and
dynamic covered-call strategies.

3.2 Under Different Market Conditions

Financial products in different market conditions tend to behave differently. This study
refers to the setting of Che and Fund (2011), dividing Taiwan's market into four conditions
(sharply falling, moderately falling, sharply rising, and moderately rising). The results are
shown in Tables 4 to 6.
In the average return of seven probabilities, in the sharply falling market, selling options close to ATM can receive more premiums, and the dynamic adjustment covered-call
(both under Black and Heston models) can effectively reduce losses. In moderately falling
market, the dynamic covered-call strategy is better than the conventional strategy under
Black model, and the performance of Heston model is worse than Black model. However,
in the character of sensitive market in Taiwan, there are only four months in moderately falling situation in our studied periods. Even so, Heston model is still better than the naked futures position.

In the sharply rising market, all the covered-call strategies are worse than the naked futures; however, if we evaluate the performance under Sharpe ratio, the covered-call strategies are better than the naked futures, as they can effectively reduce the risks. We can still
point out that Heston model is better than Black model in the moderately rising market.
More specifically, we can find out that the Black and Heston models choose the same
probabilities of the closest ATM in sharply falling market and of the deeply OTM in sharply
rising market. The most interesting part is that Heston model chooses to receive more premium than Black model in the case of the moderately falling market and to receive fewer
premiums than Black model in the moderately rising situation in order to reduce the probability of exercise. Overall, it is the reason why the Heston model can perform better than
Black model.
Table 4 Overall monthly performance of fixed strike strategy under
different market conditions.
Sharply Falling
N=33

1%
OTM

2%
OTM

3%
OTM

4%
OTM

5%
OTM

6%
OTM

-3.39%

-1.86%

-2.07%

-2.14%

-2.34%

-2.45%

-2.55%

7.54%

6.26%

6.44%

6.73%

6.90%

7.10%

7.20%

Coefficient of Variation, CV

-2.2245

-3.3636

-3.1179

-3.1442

-2.9512

-2.8950

-2.8242

Median

-2.75%

0.11%

-0.54%

-1.11%

-1.11%

-1.51%

-1.54%

Max

11.16%

5.98%

5.98%

7.30%

7.34%

8.77%

8.91%

Mean
SD

Min

Pure Future

-18.72% -17.43% -17.79% -18.07% -18.07% -18.29% -18.42%

Semi-SD

7.53%

5.99%

6.20%

6.76%

6.58%

6.73%

6.84%

Sharpe Ratio

-44.95% -29.73% -32.07% -31.80% -33.88% -34.54% -35.41%

Sortino Ratio

-45.01% -31.06% -33.36% -31.65% -35.52% -36.41% -37.27%

Moderately Falling
N=5

1%
OTM

2%
OTM

3%
OTM

4%
OTM

5%
OTM

6%
OTM

-1.65%

-0.93%

-0.77%

-0.89%

-1.03%

-1.18%

-1.32%

4.83%

4.11%

4.53%

4.81%

4.85%

4.95%

4.92%

Coefficient of Variation, CV

-2.9227

-4.4095

-5.8795

-5.3795

-4.6892

-4.1767

-3.7410

Median

-0.74%

0.94%

0.94%

0.49%

0.15%

-0.17%

-0.17%

Mean
SD

Pure Future

Max

3.76%

2.56%

3.14%

4.08%

4.31%

4.31%

4.11%

Min

-7.99%

-6.62%

-7.06%

-7.37%

-7.37%

-7.60%

-7.74%

4.24%

3.44%

3.61%

3.82%

3.88%

3.88%

4.10%

Semi-SD

Sharpe Ratio

-34.22% -22.68% -17.01% -18.59% -21.33% -23.94% -26.73%

Sortino Ratio

-39.00% -27.15% -21.35% -23.44% -26.64% -30.49% -32.08%

Moderately Rising
N=23

Pure Future

1%
OTM

2%
OTM

3%
OTM

4%
OTM

5%
OTM

6%
OTM

Mean

0.75%

0.46%

0.54%

0.57%

0.63%

0.74%

0.75%

SD

4.97%

3.10%

3.43%

3.70%

4.01%

4.30%

4.46%

Coefficient of Variation, CV

6.6361

6.7223

6.3774

6.4553

6.3483

5.8328

5.9193

Median

0.32%

1.85%

1.62%

1.32%

1.07%

0.78%

0.50%

Max

8.41%

3.12%

3.76%

4.41%

4.90%

6.02%

6.31%

Min

-11.18%

-9.31%

-9.84%

3.15%

2.45%

2.64%

2.72%

2.84%

2.94%

2.96%

Sharpe Ratio

15.07%

14.88%

15.68%

15.49%

15.75%

17.14%

16.89%

Sortino Ratio

23.79%

18.82%

20.39%

21.09%

22.22%

25.12%

25.48%

1%
OTM

2%
OTM

3%
OTM

4%
OTM

5%
OTM

6%
OTM

Semi-SD

Sharply Rising
N=34

Pure Future

-9.84% -10.24% -10.60% -10.60%

Mean

3.93%

2.18%

2.46%

2.77%

3.02%

3.17%

3.36%

SD

5.24%

2.43%

2.64%

2.95%

3.28%

3.53%

3.83%

Coefficient of Variation, CV

1.3327

1.1189

1.0723

1.0658

1.0870

1.1118

1.1371

Median

3.24%

2.49%

3.12%

3.44%

3.72%

3.60%

3.48%

Max

15.65%

4.54%

5.39%

5.87%

6.48%

7.51%

7.64%

Min

-9.60%

-8.30%

-8.63%

-8.92%

-9.15%

-9.31%

-9.31%

2.10%

1.59%

1.64%

1.74%

1.82%

1.85%

1.89%

75.03%

89.37%

93.26%

93.83%

92.00%

89.95%

87.94%

Semi-SD
Sharpe Ratio
Sortino Ratio

186.89% 136.97% 149.41% 159.44% 165.77% 171.64% 177.80%

Table 5 Overall monthly performance of dynamic (Black) strike strategy under different market conditions.
Sharply Falling
N=33
Mean
SD

49%

42%

36%

30%

25%

20%

0.17

-1.62%

-1.99%

-2.12%

-2.33%

-2.56%

-2.81%

-2.90%

5.89%

6.34%

6.82%

7.19%

7.34%

7.41%

7.52%

-3.6398

-3.1905

-3.2158

-3.0846

-2.8650

-2.6425

-2.5946

Median

0.88%

-0.04%

-1.11%

-1.36%

-1.67%

-2.24%

-2.45%

Max

5.25%

5.98%

8.77%

10.39%

11.31%

10.49%

10.49%

Coefficient of Variation, CV

Min
Semi-SD

-16.95% -17.43% -17.79% -18.07% -18.29% -18.42% -18.42%

5.64%

6.10%

6.44%

6.74%

6.94%

7.14%

7.24%

Sharpe Ratio

-27.47% -31.34% -31.10% -32.42% -34.90% -37.84% -38.54%

Sortino Ratio

-28.66% -32.59% -32.96% -34.59% -36.93% -39.32% -40.03%

Moderately Falling
N=5

49%

42%

36%

30%

25%

20%

0.17

-0.84%

-0.67%

-0.49%

-0.79%

-0.85%

-1.10%

-1.20%

3.64%

4.19%

4.60%

4.77%

4.75%

4.76%

4.71%

-4.3111

-6.2609

-9.2947

-6.0729

-5.5613

-4.3258

-3.9108

Median

1.56%

0.94%

0.94%

0.49%

0.15%

0.15%

-0.17%

Max

1.93%

3.14%

4.08%

4.31%

4.31%

3.98%

3.98%

Min

-6.03%

-6.62%

-6.62%

-7.06%

-7.06%

-7.37%

-7.37%

3.09%

3.32%

3.44%

3.70%

3.70%

3.88%

3.88%

Mean
SD
Coefficient of Variation, CV

Semi-SD
Sharpe Ratio

-23.20% -15.97% -10.76% -16.47% -17.98% -23.12% -25.57%

Sortino Ratio

-27.36% -20.15% -14.39% -21.25% -23.10% -28.34% -30.99%

Moderately Rising
N=23

49%

42%

36%

30%

25%

20%

0.17

Mean

0.46%

0.41%

0.46%

0.55%

0.49%

0.61%

0.56%

SD

2.84%

3.04%

3.25%

3.52%

3.72%

3.98%

4.06%

Coefficient of Variation, CV

6.1398

7.4142

7.0887

6.3627

7.5160

6.5247

7.2191

Median

1.60%

1.61%

1.32%

1.62%

1.62%

1.07%

1.07%

Max

2.72%

3.12%

3.74%

4.41%

4.90%

5.83%

5.83%

Min

-8.69%

-9.31%

-9.84%

2.32%

2.45%

2.54%

2.65%

2.75%

2.85%

2.87%

Sharpe Ratio

16.29%

13.49%

14.11%

15.72%

13.30%

15.33%

13.85%

Sortino Ratio

20.01%

16.77%

18.08%

20.83%

18.00%

21.46%

19.57%

9%

42%

36%

30%

25%

20%

0.17

Mean

1.74%

2.20%

2.47%

2.85%

2.94%

3.22%

3.30%

SD

2.11%

2.45%

2.73%

3.14%

3.45%

3.78%

4.02%

Coefficient of Variation, CV

1.2080

1.1139

1.1059

1.1043

1.1730

1.1737

1.2191

Median

1.98%

2.44%

2.72%

3.18%

3.28%

3.46%

3.46%

Max

3.70%

5.39%

5.87%

7.49%

7.51%

8.95%

10.03%

Min

-7.92%

-8.30%

-8.30%

-8.63%

-8.92%

-8.92%

-9.15%

1.47%

1.58%

1.64%

1.77%

1.91%

1.95%

2.02%

82.78%

89.78%

90.42%

90.56%

85.25%

85.20%

82.02%

Semi-SD

Sharply Rising
N=34

Semi-SD
Sharpe Ratio
Sortino Ratio

-9.84% -10.24% -10.60% -10.60%

118.42% 139.11% 150.76% 160.69% 153.80% 165.10% 163.62%

Table 6 Overall monthly performance of dynamic (Heston) strike strategy under different
market conditions.
Sharply Falling
N=33

49%

42%

36%

30%

25%

20%

0.17

-1.84%

-2.05%

-2.20%

-2.36%

-2.53%

-2.67%

-2.78%

6.24%

6.55%

6.92%

7.19%

7.43%

7.61%

7.62%

-3.3843

-3.1941

-3.1406

-3.0527

-2.9381

-2.8460

-2.7443

Median

0.11%

-0.54%

-1.11%

-1.36%

-1.96%

-2.24%

-2.26%

Max

5.98%

7.30%

8.70%

9.79%

10.63%

12.35%

12.15%

Mean
SD
Coefficient of Variation, CV

Min

-17.43% -17.79% -18.07% -18.07% -18.29% -18.29% -18.42%

Semi-SD

5.97%

6.23%

6.51%

6.73%

6.95%

7.09%

7.17%

Sharpe Ratio

-29.55% -31.31% -31.84% -32.76% -34.04% -35.14% -36.44%

Sortino Ratio

-30.89% -32.89% -33.85% -35.02% -36.36% -37.73% -38.74%

Moderately Falling
N=5

49%

42%

36%

30%

25%

20%

0.17

-0.81%

-0.68%

-0.94%

-0.90%

-1.04%

-1.10%

-1.21%

4.19%

4.38%

4.56%

4.69%

4.89%

4.83%

4.80%

-5.1728

-6.4412

-4.8511

-5.2111

-4.7019

-4.3909

-3.9669

Median

1.56%

0.94%

0.49%

0.15%

-0.17%

-0.17%

-0.34%

Max

2.56%

3.14%

3.14%

4.08%

4.31%

4.31%

4.11%

Min

-6.62%

-6.62%

-7.06%

-7.06%

-7.37%

-7.37%

-7.37%

3.44%

3.44%

3.70%

3.70%

3.88%

3.88%

3.93%

Mean
SD
Coefficient of Variation, CV

Semi-SD
Sharpe Ratio

-19.29% -15.59% -20.66% -19.24% -21.20% -22.71% -25.23%

Sortino Ratio

-23.54% -19.86% -25.48% -24.39% -26.69% -28.27% -30.82%

Moderately Rising
N=23

49%

42%

36%

30%

25%

20%

0.17

Mean

0.53%

0.50%

0.65%

0.52%

0.66%

0.63%

0.66%

SD

3.03%

3.14%

3.47%

3.68%

3.98%

4.14%

4.33%

Coefficient of Variation, CV

5.7563

6.3185

5.3668

7.1160

6.0518

6.6185

6.5774

Median

1.85%

1.94%

1.94%

1.32%

1.07%

0.78%

0.72%

4.41%

4.90%

5.83%

5.83%

7.38%

Max

3.12%

3.12%

Min

-9.31%

-9.31%

2.42%

2.45%

2.59%

2.74%

2.79%

2.90%

2.93%

Sharpe Ratio

17.37%

15.83%

18.63%

14.05%

16.52%

15.11%

15.20%

Sortino Ratio

21.77%

20.30%

24.93%

18.89%

23.57%

21.53%

22.43%

Semi-SD

-9.84% -10.24% -10.24% -10.60% -10.60%

Sharply Rising
N=34

49%

42%

36%

30%

25%

20%

0.17

Mean

2.27%

2.61%

2.92%

3.06%

3.24%

3.55%

3.55%

SD

2.38%

2.81%

3.12%

3.37%

3.62%

3.96%

4.04%

Coefficient of Variation, CV

1.0458

1.0782

1.0676

1.1019

1.1165

1.1153

1.1376

Median

2.50%

3.02%

3.18%

3.44%

3.76%

3.60%

3.59%

Max

4.54%

6.42%

7.51%

7.51%

8.77%

9.09%

9.71%

Min

-8.30%

-8.63%

-8.63%

-8.92%

-9.15%

-9.15%

-9.31%

1.60%

1.77%

1.81%

1.91%

1.94%

1.95%

1.97%

95.62%

92.74%

93.67%

90.75%

89.57%

89.66%

87.90%

Semi-SD
Sharpe Ratio
Sortino Ratio

141.58% 147.58% 161.09% 160.48% 167.14% 182.12% 179.89%

Finally, we calculated the cumulative total return on the naked futures, fixed strike
strategy with OTM 3%, and both dynamic strategies with the exercised probability around
30%. Although there are lightly different criterions between fixed and dynamic strategies, it
is worthy of understand how the volatility to influence the total return over the all periods.
As shown as figure 7, there are significant benefits to adopt the covered call strategy whether
you use fixed strategy or dynamic strategy. Before the financial credit crisis of 2008, there
are no obvious differences between the performances of the Black model and of the Heston
model. However, the fixed strike strategy outperforms among all strategies before year
2008. In the rapidly descending periods in 2008, all strategies performed equally. After the
valley bottom, the index bounced fast. The call option position was suffered from exercising by the buyers. The Heston model can properly adjust the moneyness. The advantage can
also be discove red in Table 7. If we use other criterions with exercised probabilities, it will
be found that the Heston model indeed performs better than Black model obviously.

Cumulative Total Return

50%
40%
30%
20%
10%
0%
-10%
-20%
-30%

Fixed Strike

Dynamic (BS)

20111116

20110518

20110817

20110216

20101117

20100519

20100818

20091118

20100222

20090819

20090520

20081119

20090218

20080521

20080820

20080220

20070815

20071121

20070516

20070226

20060816

20061115

20060215

Future

20060517

20051116

20050518

20050817

20041117

20050216

20040818

20040218

-50%

20040519

-40%

Dynamic (Heston)

Figure 7 The cumulative total return on the futures, fixed strike strategy with the
OTM 3%, dynamic (BS) strategy and dynamic (Heston) strategy with the
exercised probability around 30%.

Table 7 The performance is under conventional strategy and dynamic strategies

(Black and Heston models).
Total Period

0.17

0.2

0.25

0.3

0.36

0.42

0.49

Average

Black Model

0.2464%

0.2673%

0.2382%

0.3016%

0.2319%

0.1626%

0.1297%

0.2254%

Heston Model

0.4018%

0.4354%

0.3873%

0.3544%

0.3859%

0.3052%

0.2574%

0.3610%

Sharply Falling

0.17

0.2

0.25

0.3

0.36

0.42

0.49

Fixed Moneyness

0.3307%

Fixed Moneyness

Average

Black Model

-2.8994% -2.8057% -2.5626% -2.3317% -2.1213% -1.9867% -1.6173% -2.3321%

-2.7777% -2.6742% -2.5286% -2.3556% -2.2035% -2.0502% -1.8442% -2.3477%

Fixed Moneyness

0.3225%
Pure Future

-2.2347%

Heston Model
Moderately Falling

Pure Future

0.17

0.2

0.25

0.3

0.36

0.42

0.49

Average

-3.3903%
Pure Future

-1.0219%

Black Model

-1.2035% -1.1006% -0.8548% -0.7861% -0.4946% -0.6690% -0.8443% -0.8504%

Heston Model

-1.2120% -1.0978% -1.0366% -0.9024% -0.9426% -0.6824% -0.8089% -0.9547%

-1.6542%

Moderately Rising

0.17

0.2

0.25

0.3

0.36

0.42

0.49

Fixed Moneyness

Average

Pure Future

0.6158%

Black Model

0.5622%

0.6107%

0.4947%

0.5529%

0.4585%

0.4101%

0.4633%

0.5075%

Heston Model

0.6582%

0.6254%

0.6581%

0.5174%

0.6460%

0.4966%

0.5268%

0.5898%

Sharply Rising

0.17

0.2

0.25

0.3

0.36

0.42

0.49

Average

Fixed Moneyness

0.7491%
Pure Future

2.8268%

Black Model

3.2992%

3.2187%

2.9438%

2.8475%

2.4694%

2.2034%

1.7429%

2.6750%

Heston Model

3.5515%

3.5504%

3.2437%

3.0593%

2.9185%

2.6072%

2.2716%

3.0289%

3.9282%

4. CONCLUSIONS
This paper is contributed to combine the stochastic volatility model and covered-call
strategy to get more precisely option pricing, which can make covered-call strategies more
suitable. This study examines the performances of conventional strategy and dynamic
covered-call strategies, including constant and stochastic volatilities environments in Taiwan. In overall periods, the conventional covered-call strategy under fixed ratio moneyness
has a slight increment of 1 basis point on monthly return than pure futures buy-and-hold
strategy. However, the dynamic strategy under Black model is worse than naked futures position and fixed ratio strategy. In the alternative Heston model, it can obviously improve the
performance of return in our study. Finally, this study points out that the dynamic strategy
under Heston model has the more obvious advantage than Black model.

Footnotes
1. Put option can be derived from put-call parity.
2. In the original Hestons model, the underlying asset is stock price. We use the futures index to replace
the stock index in order to consider the time consistency compared to options and the Heston model
is comparable with the Black model.

APPENDIX A
Using the dynamics as the equations 2 and 3, the probabilities can be interpreted as risk-adjusted
or risk-neutral probabilities. The probabilities Pj can be obtained by inverting the characteristic functions
fj defined below. Hence,

Pj =

i ln F
1 1 e ( ) fi
+ Re
d
2 0
i

(A-1)

for j 1,2. Where

f j = exp ( C j + D j v + i x )

C j = r iT +

Dj =

gj =

dj =

1 g j e d j T
k
b
i
d
T
2ln

(
j)
2 j

1 g j

(A-2)

b j i + di 1 ed jT

d jT
2
1 g j e
b j i + d j
b j i d j

( i b )
j

2 ( 2 j i 2 )

(A-3)

(A-4)

(A-5)

(A-6)

j 1
i = 1 is the imaginary unit, j = (1) 2 , b1 = k + , and b2 = k + . The parameter

represents the price of volatility risk as a function of the asset price, time, and volatility.
We can get the Heston (1993) call price from the closed-form formula if we have the specific parameters future price (F), strike price (X), risk free rate ( ), time to maturity (T), rho ( ), Kappa (k), Theta
( ), Lambda ( ), volatility of volatility ( ), current variance ( ).

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