A "Devil's Bargain": When Generating Income Undermines Investment Returns

Many investors are motivated by passive income. Dividend income -seeking strategies have a long history. More recently, interest in derivative income strategies-such as covered calls and put underwriting-continues to develop. Do high derivative income -covered calls tend to deliver higher total returns? No. In fact, the relationship goes the other way. The authors demonstrate a strong negative mechanical relationship between expected total return and derivative income for covered -call strategies. They empirically validate this relationship over a nearly 25 -year period on S&P 500 covered -call strategies. Those who have sought out and allocated to such strategies without accounting for this trade-off might have made a devil's bargain.