Behavioral aspects of covered call writing: an empirical investigation

Abstract

Various explanations for the popularity of covered call option strategies have been explored in the literature. According to Shefrin and Statman [1993], framing and risk aversion can help justify its attractiveness to investors. Applying prospect theory and hedonic framing, these authors predict that in a world of frame dependence an investor that is sufficiently risk averse in the domain of gains will prefer a covered call position over a stock only position and that certain covered call designs will be preferred despite identical cash flows. To date, the relationship among framing, risk aversion, and covered call writing has not been empirically tested. We gather empirical evidence to complete this gap in the literature. We find highly significant empirical evidence for a pronounced framing effect with respect to different covered call designs with equal net cash flows as well as covered calls in general. We find only scarce empirical evidence for a relationship between risk aversion in the domain of gains and a preference for covered calls. In order to observe a positive relationship between risk aversion and covered call writing, investors with above average risk aversion seem to be required.