The anomalous behavior of the S&P covered call closed end fund

Abstract

This article examines the anomalous behavior of the S&P Covered Call Closed End (BEP) Fund, which traded in 2007 at substantial premiums to its net asset value, which reached 23 per cent. The large premium is striking in light of the highly transparent and easy to replicate strategy of the fund, which involves rolling over one-month, at-the-money S&P 500 index covered calls. The article finds that the large premium was a result of BEP returns overreacting to positive S&P returns, adjusted for the deltas and gammas of the options that the fund was short. Another possible explanation for the emergence of the large premium was the near doubling of the VIX from very low and stable levels, which may have encouraged unsophisticated investors to buy the BEP fund at increasingly elevated premiums. The article then examines the anomaly from the perspective of the noise trader literature and finds that during the period of high premiums the volatility of BEP returns was not unusually high relative to the volatility of the underlying fundamentals, and that large premiums did not emerge at other covered call closed end funds. The evidence also indicates that short positions grew substantially during this period, which suggests that short covering may have been a factor behind the surge of the premium.