Harvest Strategy

An overview of the potential benefits and risks to participating in the Covered Call Strategy

TLDR

What is a covered call?

A covered call is a simple trading strategy with two components:

In return, covered call sellers receive yield via USDC premiums.

A call option has two key dimensions to consider for covered call execution:

Changing these parameters affects the yield generated by the option.

*However if you ‘roll’ the strategy by executing weekly, the yields are generally higher (with higher risk) for shorter dated rolling strategies.

Why would I sell covered calls?

Selling covered calls boils down to pre-committing to limit sell orders, and getting paid for it. In return, you sacrifice upside if the price of the asset you’re trading rapidly increases. The annualized yield afforded by selling covered calls typically ranges from 10-50% on the collateral posted.

Covered calls are generally best for:

The downside of the strategy is two-fold:

Derive Covered Call Tokens are designed to:

It is important users consult the up-to-date information on yield and points programs in the app before entering a strategy, as these are subject to change.

Example

Alan sells 100 covered calls using rswETH as collateral.

There are two possible scenarios where the outcome differs between selling covered calls and simply holding the underlying asset.

Scenario 1

ETH finishes the 7 day period at $3,400.

When ETH finishes at or below $3,500, Alan earns more than he would have had he not used the strategy.

Earnings breakdown:

Scenario 2

ETH finishes the 7 day period at $3,600.

In this case, Alan's P&L is positive, although less positive than if he had just held rswETH and not used the strategy.

Earnings breakdown:

The options Alan sold are in the money, so he needs to pay out by selling some rsWETH (at $3,600) and paying back the $10,000. In this case, Alan would need to sell $10,000/$3,600 = 2.78 swETH, and he would be left with 97.22 swETH plus the yield he earned.

Strategy Risk

This is the drawback of selling options. You can end up selling cheap if the asset price rallies quickly (in the case of Scenario 2 above, ETH rallied 20% in a week).

But even if that happens and you lose on the options trade, it’s not necessarily a net loss. In scenario 2, Alan's P&L across his portfolio is positive. That’s because his rswETH holdings increased in value from $300,000 to $360,000 (+$60,000). Those profits dampen the loss from paying off the options obligations. When you add the premiums and yield, this more than makes up for the loss. But that is the risk of the strategy. You may miss out on some upside in return for income and yield.

Conclusion

Derive vaults are aimed at existing holders of the underlying asset. However, if you decide to purchase the underlying asset to mint Covered Call Tokens, please be aware of the extra risks involved (detailed here).

Derive's Covered Call Tokens allow users to execute the covered call strategy with the underlying asset as collateral. Covered calls are a powerful and sustainable strategy for traders and investors who want to generate yield on their assets through options selling. In return for giving up potential upside in their asset, they receive yield.

Traders should understand the strategy and weigh up the risk/reward profile before participating.