The Small Cap Covered Call Yield Pick-Up

Beyond the well-documented size premium, which refers to the historical tendency for small-cap stocks to outperform large caps over long periods (as outlined by Fama and French), small caps may also offer a key advantage for income-focused investors.

This advantage isn’t limited to dividends. When liquidity conditions are healthy and a robust options market exists, buy-write or covered call strategies on small-cap names can often command higher option premiums.

All else being equal, a small-cap covered call strategy can potentially generate more income than a large-cap equivalent, thanks to the underlying mechanics of options pricing.

Here's an instructive example using index options on both the S&P 500 Index (SPX) and the Russell 2000 Index (RUT).

Quantifying the yield pick-up

One of the less talked-about advantages of small-cap indexes is their potential to generate higher income through covered call strategies.

To see this in action, let’s compare at-the-money (ATM) or slightly out-of-the-money (OTM) call options on the RUT and the SPX, both expiring July 11, 2025.

At the time of observation (June 25th, 2025):

• Russell 2000 Index (RUT): 2,144.19

• S&P 500 Index (SPX): 6,091.85

• RUT 2145 call option: $48.90

• SPX 6090 call option: $76.40

These contracts are effectively a similar distance from the current index level and have identical expiry dates, so we can isolate and evaluate one thing: the yield differential.

To compare income potential, we calculate the yield from the premium collected as a percentage of the index level:

• RUT yield = $48.90 / 2,144.19 = ~2.28%

• SPX yield = $76.40 / 6,091.85 = ~1.25%

This means writing a two-week covered call on the Russell 2000 currently offers almost double the income compared to the same trade on the S&P 500. The difference comes down to one core factor: implied volatility.

When option expiration and moneyness are roughly equivalent, implied volatility becomes the dominant input into option pricing. And the Russell 2000, as a small-cap index, tends to exhibit significantly higher volatility than its large-cap counterpart. Putting it together:

1. Higher volatility = Greater probability the option finishes in the money.

2. Greater probability = Higher premium buyers have to pay to compensate for the risk.

3. Higher premium = Higher yield for the seller of the call.

The higher premium compensates sellers for the added risk that the more volatile index rises above the strike and the call is exercised.

In practice, this dynamic means small-cap indexes like RUT may consistently offer a higher covered call yield potential, assuming there are no temporary distortions in pricing for certain contracts.

How to put it in practice

One important caveat with using Russell 2000 index options, or options on a Russell 2000 ETF for a covered call strategy is the nature of the underlying itself.

In a buy-write strategy, you're implicitly long the asset. So before anything else, you need to ask: Is this something I actually want to own?

That question matters because a non-trivial portion of the Russell 2000 consists of unprofitable companies, many of which have negative earnings or operate with persistently low margins.

Using cash-settled index options avoids direct ownership, but selling covered calls on a Russell 2000 ETF exposes you to a potentially lower-quality portfolio. In our view, that's not optimal for income-first investors.

Instead, we prefer a more selective approach: screening for small-cap stocks that are profitable, pay consistent and meaningful dividends, and trade at valuations that make sense based on earnings growth and cash flows.

The idea is to start with a fundamentally sound equity base that’s attractive to own over the long term, even without the options overlay.

Once a solid foundation for small-cap ownership is established, investors can still benefit from the higher volatility of the segment as a whole by selling cash-settled Russell 2000 index options.

It’s a way to capture elevated premiums while maintaining a quality-focused portfolio, potentially offering the best of both worlds.

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About Us

Jay D. Hatfield is CEO of Infrastructure Capital Advisors and is the lead portfolio manager of the Infrastructure Capital Bond Income ETF (NYSE: BNDS), InfraCap Small Cap Income ETF (NYSE: SCAP), InfraCap Equity Income Fund ETF (NYSE: ICAP), InfraCap MLP ETF (NYSE: AMZA), Virtus InfraCap U.S. Preferred Stock ETF (NYSE: PFFA), InfraCap REIT Preferred ETF (NYSE: PFFR) and private funds. Each month Infrastructure Capital hosts a monthly economic webinar; you can sign up to attend by visiting our website www.infracapfunds.com (important disclosures can also be found on the website). For a prospectus please reach out to us or visit the links above for each respective fund.

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