Thread by @KirtanShahCFP

Parag Parikh Long Term Equity fund will be introducing 'covered call strategy' in the fund. This can be a game changer for the fund in a market that does not steeply go up or moves up gradually or stays sideways or even falls (1/n)

Options is slightly difficult to explain over twitter, so here’s my video on ‘basics of options’, do subscribe to my channel ☺ (2/n)

How does a cover call work?
When a fund buys a stock, they expect it to go up. But they don’t make returns if the stock stays sideways or falls and is exactly where cover call comes into picture. Let me explain, (3/n)

Lets say PPFAS has invested in RIL @ the current market price of 2315. PPFAS will sell a call option of RIL at 2600 & receive a premium of 10 rupees. Selling a call option @ 2600 means the fund is nt expecting RIL 2 move above 2600 in that month (last Thursday of the month)”(4/n)

Lets see how much profit/loss does the fund make in various possible situations
Situation 1 – RIL closes the month @ 2315
Return – As the stock dint close above 2600, PPFAS will make 10 rupees of profit where as other funds holding RIL will make nothing. PPFAS at advantage(5/n)

(2)-RIL closes @ 2200
Return–The stock dint close above 2600, PPFAS will make 10 rupees of profit. While any other fund holding RIL will make a loss of 2315 – 2200 = 115, PPFAS will loss 115 – 10 = 105 as it has received 10 as premium from the call option. PPFAS at advantage(6/n)

(3)–RIL closes the month @ 2600
Return–As the stock dint close ABOVE 2600, PPFAS will make 10 rupees of profit. While any other fund holding RIL will make a profit of 2600–2315=285, PPFAS will gain 285+10=295 as it has received 10 as premium 4m d call option. PPFAS advantage(7/n)

(4)–RIL closes the month at 2640
Returns-As the stock closed above 2600, PPFAS will loose 30 rupees (2640 – 2600 = 40 but has received 10 as premium so net loss 30), as it was not expecting it to close above 2600. (8/n)

While other fund holding RIL will make a profit of 2640 – 2315 = 325, PPFAS will gain less 325 - 30 = 295. PPFAS at Disadvantage (9/n)

While theoretically people may argue saying writing a call is a risk strategy, covered call (buy the share and then selling the call) has its own advantages. 3 out of 4 probability in favor of PPFAS as explained above. (10/n)

Negatives – 1. NAV may become volatile due to market-to-market impact
2. There can be some opportunity cost loss, if after selling the call option in the interim the fund decides to sell the stock
3. If the fund size increases drastically, options may have an impact cost(11/12)

Overall it’s a win – win in my opinion. (END)

Just to clarify, it is not necessary that the fund will always and at all times use it. They might use it only when they think it is prudent. They are currently only adding this as a provision.