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Stocks

A Covered Call Fund

Benchmark has provided a draft offer document for a covered call fund – essentially buying a future and writing a call option on it at the same time. SEBI hasn’t yet approved it, but it should: after all we need more than simple funds that invest in stocks.

Covered calls have the advantage that your downside is covered as much premium as you receive for the call option. So if you buy a Nifty future at say 4500 and sell a 4500 call for Rs. 100, you are “covered” till 4400. Below that you lose as much as the Nifty itself. And you make only Rs. 100 if the Nifty goes above 4600. Limited return, unlimited risk, but it makes sense for random markets which don’t seem to go anywhere.

Now this Benchmark fund only invests in Nifty options because, I imagine, the liquidity is only in those options. But it will do both covered calls and puts, which should be a good thing as they will make money both ways.

But the problem is the “Benchmark Index”. Typically you link to an appropriate index like the Nifty, or the BSE 200 or such. But this fund benchmarks against the India VIX index.

This is plain silly.

Why? The VIX is a volatility index and will be anywhere between 0 and 100%. It can increase or decrease daily – a few days ago it was 62% and today it is 35%. So how do they use it as a benchmark? Will you expect 62% returns three days back and 35% today? It cannot be used as an index. You can’t even plot values of it and take it as a benchmark. The only way to benchmark a covered call fund is, well, either a fixed deposit or no benchmark. It’s better tahn attempting to benchmark with a percentage.

But this is a good start – covered call funds are important to have and can form good measures of index volatility as well. More power to them. They also have an oil and silver fund but SEBI hasn’t approved them. Perhaps SEBI needs to get these and other such draft documents approved or rejected faster; there are hundreds awaiting clearance.

  • Adheer Pai says:

    >Does SEBI allow mutual funds to maintain leverage ? I don't think so, but I may be wrong.

    Secondly, comparing leveraged funds to benchmark indices can be deceptive – unless there is a disclosure on the amount of leverage, or risk-adjusted-returns.

  • Deepak Shenoy says:

    >Covered Call funds are allowed by Sebi – they are treated as "hedged with derivatives" so not treated as leverage.

  • chemengg00 says:

    >Hi Deepak, I do a lot of covered call writing so I enthusiastically read your article on covered call fund. Can you please tell me if such fund is available in India ? Lucio