Covered Calls for the Long Run

In another sign of the continued, growing interest in such funds, Eaton Vance raised a whopping $875 million in January for its closed-end Enhanced Equity Income Fund(EOS Quote), which will write covered calls "on a substantial portion of the portfolio," according to the prospectus.

The advantage of a closed-end fund is that it typically pays out a higher dividend. The disadvantage is that it can have higher costs than many traditional mutual funds; Madison Claymore charges an annual fee of 1% and First Trust's fee is 1.22% of assets under management, which is on top of transaction costs. Also be aware that the funds, due to the limited shares available, can trade at premium to their actual net asset value, leaving holders vulnerable to a sudden price discount.

Still, it's important to understand that nearly all covered-call funds (or those that use put options for either income or protection) retain discretion for the fund manager to adjust the beta or net exposure of the position. For example, Frank Burgess, the portfolio manager for the Madison Claymore fund, says he will sell calls against roughly 80% of the fund's holdings at any given time."

The Bridgeway fund writes calls against only 10% of the total portfolio at one time but will sell puts to establish new long positions or create bullish exposure in individual issues. "Implied volatilities help us identify which are the best options to sell regarding strike and expiration but are not part of the stock selection screening process," says fund manager Richard Cancelmo. By comparison, Kelmoore searches for high-volatility situations in which to write options and also writes puts as a means of establishing a long position.

Dividend distribution will also be an important consideration in determining which product will best help meet your investment goals. The BXM is calculated on dividends being reinvested; some funds such as Bridgeway also reinvest, while others pay out a healthy dividend.

If you want to take the manager's discretion out of the equation, consider the Morgan Stanley Strategic Total Return Securities (MBS Quote) fund. This is an exchange-traded fund (ETF) whose value is based on the daily closing price of the CBOE's BXM BuyWrite Index. The securities were issued last November at a price of $10 per unit and have a maturity date of Dec. 17, 2009.

Although recent listing of SPY options makes it relatively easy for an individual to replicate the BXM, this is still a fairly labor-intensive process in which emotions can easily lead you astray. So unless your transaction costs are low and your disposition is aligned for a long-term investment horizon, it may be better to let a professional manage the portion of your assets designated for a covered call program.