The Anomalous Behavior of the S&P Covered Call Closed End Fund

Abstract

This paper examines the anomalous behavior of the S&P Covered Call Closed End (BEP) Fund, which traded in 2007 at substantial premiums to its NAV that reached 23 percent. 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 paper finds that the large premium owed to 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 is 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 paper then examines the anomaly from the perspective of the noise trader literature and finds that the volatility of BEP returns was 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 suggests that short covering may have been a factor behind the surge of the premium as short positions grew substantially during this period, consistent with the noise trader model of Abreu and Brunnermeier (2002) that emphasizes the timing risk associated with arbitrage.