Reexamination of the Covered Call Option Strategy

Traditionally, corporations faced with the problem of managing short-term cash reserves have relied almost exclusively on investments in the money market. Recently, however, financial strategists have developed several innovations designed to take advantage of the benefits of short-term equity participation. Most notable among the methods suggested thus far is the "hedged dividend capture" plan, wherein the stock of a company about to pay a dividend is purchased at the same time a call option is sold. The resulting covered call position is then liquidated soon after the dividend is received.

The primary advantage of this scheme is the company's ability to obtain the 85% tax exclusion on dividend income while protecting against price fluctuations in the underlying stock issue. Indeed, the rewards of employing the hedged dividend capture approach can be dramatic. Brown and Lummer found that the covered call technique led to an almost 300% increase in the after-tax yield offered by Treasury issues, while reducing the number of unhedged stock positions that lost money by almost 50%