How should investors think about covered calls within an asset allocation. Are they core, part of the income sleeve, or primarily used to help mitigate volatility?
Overview
The Shelton Equity Income Strategy is a separately managed account that combines a portfolio of U.S. large-cap stocks with covered calls written on individual holdings. The strategy is designed for clients who want to maintain equity market exposure while pursuing a more income-oriented approach through disciplined stock selection and active covered call management.
Strategy Objective
The Shelton Equity Income Strategy seeks to increase cash flow and reduce overall volatility by building a portfolio of carefully selected U.S. large-cap stocks and selling calls on the individual holdings within the portfolio.
Where The Strategy Can Fit
The strategy may be relevant as a core or complementary equity allocation for clients seeking:
- Cash flow from a covered call overlay.
- Large-cap equity exposure with a disciplined stock-by-stock option writing process.
- A more customized implementation approach through an SMA.
- An SMA structure with potential tax-loss-harvesting opportunities in taxable accounts.
- A more moderated risk profile compared to a traditional long-only large-cap portfolio.
How Shelton Builds The Portfolio
The Equity Income Strategy invests primarily in a diversified portfolio of large-cap U.S. equities and writes covered calls on individual stocks held in the strategy.
We start with the S&P 500, a universe of widely held large-cap US stocks in the industrial, transportation, utility, and financial sectors which are selected by the S&P Index Committee, a team of analysts and economists at Standard & Poor’s.
Using a proprietary screening process, equities are then ranked on a scorecard by an internal cash flow analysis that focuses on volatility, dividend income received, along with capital appreciation.
Using an additional fundamental screen, stocks are filtered by a variety of criteria, including free cash flow yield and price to sales ratios. The highest ranking equities are then selected in each of 11 sectors to closely replicate the sector weightings of the S&P 500 Index. The Portfolio Manager has a preference for large-cap stocks with attractive dividend yields.
Finally, we identify and purchase roughly 40 equities which we believe have the most over-priced call options. We strategically write (sell) those covered calls two to twelve times per year to generate cash flow in addition to the portfolio’s dividend yield.
Why Investors Consider A Covered Call SMA
- Cash-flow-oriented approach, combining covered call premiums and portfolio dividends.
- Diversified large-cap equity portfolio with sector construction designed to reflect the S&P 500.
- Designed to reduce portfolio volatility while retaining potential for limited capital appreciation.
- Full portfolio transparency and comprehensive reporting.
- Direct access to the portfolio management team.
- SMA structure that may provide greater customization than a pooled vehicle.
Annual Cash Flow
Base Index data provided by Bloomberg
Management Team
Barry Martin, CFA
Nick Griebenow, CFA
Jason Goldenberg
Jake Gallion
Common Questions
The Shelton Equity Income Strategy is a separately managed account that combines a portfolio of large-cap U.S. equities with covered calls written on individual holdings.
The strategy seeks cash flow through two sources: income from the underlying equity portfolio and option premiums generated by writing covered calls on individual stock holdings.
Covered calls written on individual stocks can give the portfolio management team more flexibility than a broad, uniform overlay approach because decisions can be made at the position level. Rather than applying a single set of parameters across an entire portfolio, this allows the team to choose the holdings they want to overwrite, along with the appropriate strike price and expiration.
The strategy may serve as a core or complementary equity income allocation for clients who want to remain invested in equities while adding a more cash-flow-oriented approach. The SMA structure may also provide greater flexibility around customization, portfolio visibility, and tax management than a pooled vehicle.
No. Any projected cash flow or return range is an estimate only. It is based on the characteristics of the underlying stocks and current market conditions. There is no guarantee that any cash flow target will be met, and there is no guarantee that price targets will be achieved under prevailing market conditions.
Contact Us for More Information
We have a team of professionals dedicated to supporting the needs of our advisor clients.
Important Considerations
A covered call strategy limits upside potential for stock appreciation and is therefore likely to underperform in strong markets.
A covered call does not protect a stock from downside risk. The loss for the investor on each position could be the current price of a stock minus the premium received for the call option.
Withdrawals, including systematic withdrawals as part of an income strategy, may result in a declining portfolio value over time.
All investments involve risk, including the possible loss of principal. There can be no assurance that the strategy will achieve its investment objective.
If securities are called away, substantial capital gains tax could be incurred.
The sale of stock will produce tax consequences for U.S. taxpayers. Each option transaction also produces a tax consequence. Investors should discuss with their personal tax advisor how option transactions and any sales of underlying stock may affect their tax situation. Shelton Capital Management does not provide tax advice.
INVESTMENTS ARE NOT FDIC INSURED OR BANK GUARANTEED AND MAY LOSE VALUE.
