What is a covered call?

A covered call strategy involves generating passive yield from selling (writing) call options on an asset that you own (eg. SOL). In exchange for earning the premium from the option buyer, the seller gives away the right to purchase the asset at the agreed-upon strike price. It’s important to remember that this strategy doesn’t utilize any leverage or token emissions, since all the options are fully collateralized by the seller's holdings! (source)

Let's look at the following example. LUNA is trading at $50 and you want to write a covered call option. Friktion usually sets the strike price 15% higher than the current trading price, so in this example that would be $57.5. This covered call is then sold to a buyer in exchange for a premium (usually about 5% of the LUNA in the option). Friktion currently has a one-week epoch length. This means that after 7 days, the covered call will expire and the final price will be determined. There are three different scenarios:

• The price of LUNA stays the same, so under the strike price. In this case, nothing happens and you get the premium of about 5%.
• The price of LUNA drops lower. In this case, the LUNA in the contract becomes less valuable in terms of USD, but the covered call is not exercised. This means that the strike price was not hit and you all again left with the premium.
• The price of LUNA rises above strike price. In this case, the covered call is exercised and we are forced to sell our LUNA at the strike price, so $57.5. We are left with $57.5 and we have to buy back our LUNA at a higher price, meaning we end up with less LUNA than we started with. However, this loss is somewhat compensated by the 5% premium we get for selling the option. If we do not buy back the LUNA at a higher price, we made a profit dollar-wise as we started with $50 and ended up with $57.5. This is in addition to the premium we received for selling the contract.

The Data

First, we will look at the price of LUNA over the last 30 days to determine general trends. We can see that LUNA has been in a downtrend since the beginning of the year. However, since February, the price has been hovering between 47 UST and 57 UST.

So we do not want LUNA to rise above the strike price, as we would end up with less LUNA if we chose to buy back. The epoch length on Friktion is currently 7 days. This means that we would not want LUNA to rise more than 15% in 7 days.

In order to determine the true profitability of this covered-call strategy, we will analyse the 7-day price difference in LUNA over the past month.

Next, we'll look at the price difference over a one-week period for every day over the last month.

In table above, there is only one date where the price of LUNA was more that 15% higher a week later:

Profitability

In the tables above we can see that there was only one date where the price of LUNA was 15% higher a week later: 31-1-2022. This means that if the covered call was bought on the 31st of January, the covered call would have been executed and the LUNA would have been sold of dollars at the strike price. This would have had an impact on the profitability of the strategy over the last month.

However, in the image below we can see that Friktion only writes a covered call once a week on Friday. If we reference the table above we can that for all the dates in the image below, the price increase of LUNA over the week was less than 15%. This means that the strike price was not hit and the premium was received. We can see that the premium over the last two months was between 0.2% and 2%. After the fee for using Friktion, we can see that the return per week over the last two months was between 0.2% and 1.8%.

Conclusion

Currently, the covered-call strategy is very profitable. The last 7 covered calls were not exercised, meaning the premium of about 1% per call was collected. However, we can see that LUNA can increase significantly over a 7 day period. There were about 4 one-week periods where LUNA increase more than 10%, with one week with a 22% increase. If the covered call was written on this date, the strike price would have been hit and there would have been a slight loss in terms of LUNA. Currently, the markets are quite bearish so we do not expect large increases in prices of LUNA. The covered-call strategy seems to be a good way to still collect some LUNA in these bearish times.