Boost Portfolio Income with Covered Calls

Introduction

Imagine generating extra income from your stock portfolio—without selling any of your holdings. In today’s volatile markets, investors are increasingly turning to strategies that offer stable returns with manageable risk. One such strategy is the covered call overlay, a time-tested approach favored by conservative investors, retirees, and professional portfolio managers.

A covered call overlay involves selling a call option on a list of stocks or ETFs that you already own, in exchange for a cash premium. It adds an overlay of income atop your existing portfolio—without disrupting your core investment strategy.

At WealthEngine.AI, we apply this overlay to our Momentum, Value, and Smallcap portfolios using SPY index options. Rather than writing options on each individual stock (which can be complex and inefficient), we use a single monthly SPY call option—targeting broad market exposure and simplicity. This index-based approach monetizes volatility across the market and serves as a scalable, low-friction way to enhance income.

How It Works

• •Own the core portfolio: e.g., WealthEngine’s Momentum, Value, or Smallcap portfolio
  
• •Sell an out-of-the-money SPY call option
  
• •Collect premium for the option
  
• •Roll the position before expiry
  
• •Repeat each month
  

The overlay is non-intrusive—it does not affect your internal portfolio rebalancing, factor exposures, or stock selection. It simply generates an additional layer of income.

Why Use SPY Options Instead of Stock-Specific Options?

Using SPY options instead of individual stock options in the portfolio has several advantages:

• •Simplicity: One option trade instead of dozens
  
• •Liquidity: SPY options are among the most liquid in the world
  
• •Broad Exposure: Captures systemic volatility rather than idiosyncratic risks
  
• •Efficiency: Easier to implement, roll, and monitor
  

This makes it a clean, scalable solution for adding income without altering the core engine of WealthEngine’s portfolios.

Modeling & Simulation Framework

To test this systematically, we implemented a monthly SPY covered call strategy across WealthEngine.AI portfolios. Key design details:

• •Option strike selection: Monthly SPY call, ~0.3 delta
  
• •Execution timing: Sold at the start of the month, rolled before expiry
  
• •Pricing model: Cox-Ross-Rubinstein framework, incorporating the VIX index as a proxy for implied volatility and the U.S. 3-month Treasury yield as the risk-free rate"
  

This ensures realistic simulations grounded in actual market conditions.

Backtest Results Across WealthEngine.AI Portfolios

We applied systematic covered call overlay strategy on three WealthEngine.AI portfolios — Momentum, Value, and Smallcap. All three benefited from the overlay—exhibiting higher returns, improved Sharpe and Sortino ratios, and reduced drawdowns in most regimes.

Value Portfolio + SPY Overlay

Momentum Portfolio + SPY Overlay

Smallcap Portfolio + SPY Overlay

In all three portfolios, option premium income provided meaningful contribution to overall return and served as a buffer during market drawdowns. While covered calls offer consistent income, it limits participation in sharp bull markets since gains are capped at the strike price. Investors must weigh these trade-offs in the context of their return objectives and risk tolerance.

Conclusion

A covered call overlay—particularly one using SPY options—can be a highly effective tool for conservative investors. At WealthEngine.AI, this strategy complements our fundamentally driven portfolios by adding income while smoothing returns.

By not altering the core holdings and using liquid index options, we achieve:

• •Higher cumulative returns
  
• •Improved risk-adjusted performance
  
• •Greater resilience during volatile market phases
  

For long-term investors seeking enhanced income without materially increasing risk, the covered call overlay offers a compelling solution. As always, alignment with your investment objectives and market outlook is key.