In a stable interest rate environment the manager is not concerned about interest rates increasing which would decrease the value of their bond portfolio. In this type of environment they can earn additional income by entering into a covered call strategy which means they own the underlying asset, in this case bonds, and sell interest rate call options based on Treasury futures contracts. This strategy will provide income in the form of premiums earned from the sale of the call options. If interest rates decrease, the Treasury futures will increase in price and the call options will be exercised if the Treasury futures is above the strike price reducing the seller of the call options return. The covered call strategy does not protect against an increase in interest rates where bond values would decrease except for the amount of the premium earned on the sale of the call options. |
