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

TLDR

What is a Covered Call Spread Strategy?

A covered call spread combines a regular covered call with a higher-strike long call to limit the risk of missing out on potential upside from holding the underlying asset.

The automated Covered Call Spread Strategy consists of three components:

Covered Call Spreads vs. Covered Calls

Regular covered calls forego all upside potential of holding the underlying collateral once the price of the asset reaches a certain point. For example, if the price of ETH is $2,600 and a weETH covered call has a $3,000 strike, the position stops appreciating in dollar terms once the price of ETH reaches $3,000. This means that if ETH rallies from $2,600 to $3,600 in one week, the holder would only earn $400 in profit, missing out on on the $600 gain from the increase between $3,000 and $3,600.

Covered call spreads limit the potential missed upside for the holder. By buying a long call option with a $3,100 strike, the holder can capture all ETH gains between $2,600 and $3,600, except for the portion between $3,000 and $3,100. This way, the holder would make a $900 profit and miss out on only $100 of the potential gains, compared to missing $600 with a regular covered call.

This comes at the cost of losing a percentage of the options premiums' APY. The USDC yield from the options premiums gets reduced by approximately half.

Example

Alan sells 100 covered calls using weETH as collateral.

There are three possible scenarios where the outcome differs between selling covered call spreads and simply holding the underlying asset.

Scenario 1

ETH finishes the 7 day period at or below $3,000. When ETH finishes at or below $3,000, Alan earns more than he would have had he not used the strategy.

Earnings breakdown:

Scenario 2

ETH finishes between $3,000 and $3,100. When ETH finishes between the two strikes of the spread, the strategy performs very similarly to a regular covered call.

Earnings breakdown assuming ETH finishes at $3,100:

The options Alan sold are in the money, so he needs to pay out by selling some weETH (at $3,100) and paying back the $10,000. In this case, Alan would need to sell $10,000 / $3,100 = 3.23 weETH, and he would be left with 96.77 weETH plus the yield he earned.

Scenario 3

ETH finishes above $3,100. When ETH finishes above the higher ''protection strike'', the strategy's losses are limited to $100 per weETH.

Earnings breakdown assuming ETH finishes at $3,600:

The spreads Alan sold are in the money, so he needs to pay out by selling some weETH (at $3,100) and paying back the $10,000 (note that despite ETH finishing $600 above the strike price, Alan only needs to pay $100 per option. In this case, Alan would need to sell $10,000 / 3,600 = 2.78 weETH, and he would be left with 97.22 weETH plus the yield he earned.