The option premium income is a function of the underlying's implied volatility. The higher the implied volatility, the higher the premium that can be earned from selling optionality. As volatilities tend to spike in times of distress, selling call options tends to provide more income in bear markets and thus provide some degree of downside cushioning. For instance, during the Global Financial Crisis, option premia would have been 3 or 4 times greater, compared to a normal environment. High implied volatilities also give the option overlay portfolio manager more leeway to earn a decent premium income and set a higher strike price, so the portfolio could benefit to a larger degree from a potentially V-shaped rebound after a sharp drawdown.
Option overlay benefits especially in down markets
The option overlay is expected to contribute differently depending on the general market environment. While call options sold will generate premium income in all market environments, those options' contribution to the portfolio's return will depend on whether they end in- or out-of-the-money. In strongly rising markets, it is likely that a number of stocks went up by more than the strike level, thus options may end in-the-money and the seller has to compensate the buyer of the option. In sideways markets, results can vary. In case of strongly diverting individual stock returns, there is a chance options end in-the-money. In case of low stock return dispersion, the call overlay is likely making a positive contribution. As markets fall, the probability of the call overlay contributing positively is very high as most if not all options end out-of-the-money. This is when a call overlay will be most beneficial for investors.