How Options Can Supercharge Your Retirement Income

If you are lucky, and make more good decisions than bad ones, you will one day find yourself gray-haired, in good health, and with plenty of money.

You will likely have most everything you could want or need, but you will still be interested in generating income. A reader asked for direction on this phase in life when there are no more big paydays, you have run your race, and time is measured in years, not decades.

One solution to generating income is enhancing the financial industry’s advice to diversify investments, often among exchange-traded funds that charge low fees.

During the wealth accumulation phase, that advice is fine, as money compounds over time. In retirement, though, many people bristle when told they will outlive their money if they withdraw more than 3% to 4% of their assets each year.

Investors comfortable with trading options can monetize the natural ebb and flow of blue-chip stocks to generate income. The approach is best suited for people with at least a few million dollars, though the strategy is scalable.

Here’s how it works: Create a separate taxable or nontaxable brokerage account. Make sure the account is approved for the sale of cash-secured puts and covered calls. Fund a high-yielding money-market fund with enough cash to finance cash-secured put sales. (Puts give holders the right to sell a security at a set price and time, while calls give holders the right to buy a security at a set price and time.) Avoid using leverage at all costs.

Identify nonspeculative stocks you wouldn’t mind owning and that ideally pay dividends. Set aside enough cash to trade five to 10 put contracts per stock—the equivalent of 500 to 1,000 shares.

Sell puts on these stocks that expire in a week or two and that are below the current stock price. Start conservatively—with, say, strike prices that are 5% below those of the stock—and evolve the approach as you gain experience. On the Thursday or Friday just before the expiration date, roll the puts out one week, or whatever expiration date generates a credit. Try retaining at least 60% of the premium collected when you sold the option.

If you wind up buying a stock because it drops below the put strike price and is assigned, switch to selling calls, with the goal of unloading the stock at a higher price. Analyze the stock’s trading patterns. If the stock is trending higher, pick a strike price that gives the stock room to rise.

Handle call expirations the same as puts. Operate a week or two in the future. Think of this as the administrative zone. Always adjust the option before it expires. If the stock is exercised by the call holder, sell a put and begin again.

The strategy requires focus and time. You must follow market and stock news that affects your positions. Many people lack the aptitude, or interest, to do that.

The great risk is a market crash, but that’s true for all investing. Be sure you get tax advice. The strategy is best suited for nontaxable accounts, as premiums will likely be taxed at your income level.

If you are willing to wrestle with stocks and options, you can take advantage of some time-tested facts. Options are often overpriced. Dealers expect that a never-ending horde of gamblers will always buy options to bet on stock moves. This phenomenon could define the options market if exchanges list stock options that expire in one day. Zero-dated options, as they are called, will introduce leveraged gamification into the markets, likely making options trading more like buying lottery tickets.

Such gamers occasionally win buying options, though they tend to lose far more than they make. So be it. Sometimes, you’ll sell them puts. Other times, you’ll sell them calls. Along the way, you’ll generate income for yourself just for agreeing to buy or sell blue-chip stocks.

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Originally Posted July 10, 2024 – How Options Can Supercharge Your Retirement Income