If retirement is on the horizon for you the biggest challenge you may face is yield – how can you earn a sufficient return on your money to pay your bills and allow you the comfort of stepping away from the daily grind?
You are not the only one facing the problem of earning a good yield. In this low interest rate environment, pension funds have struggled to keep up too. Even worse for them, many of their models projected “conservative” yields of 6-8% over multiple decades. But finding an asset these days producing that return predictably with conservative risk is akin to hunting for the holy grail – it may exist but it will be an arduous adventure finding it!
The reason it is so hard to find yield is not difficult to uncover. During the 2008-9 economic recession, financial markets were in turmoil and the Federal Reserve slashed rates, which was intended to have a stimulative effect on borrowing. The idea is that when rates are low, people and businesses borrow to purchase new homes and cars and to invest in new ventures.
But as much as consumers and business owners gain, so too do pensioners suffer. When interest rates are cut to minimal levels, retirees struggle to earn a return on their savings. Low rates break the social contract between government and pension holders, who expect a reasonable return on their assets when they hit retirement years.
So, what is the answer if retirement is on the horizon for you and you wish to boost your retirement income?
Boost Your Income With Options
One powerful investing strategy used by many of the most successful investors in the world, even buy-and-hold gurus like Warren Buffett, combines options with stocks to form what are called covered calls.
If you already own a stock portfolio, a covered call strategy is well worth exploring. Think of a covered call as a way to give a little extra income boost to your portfolio that would otherwise be fully reliant on share price gains and dividends to produce returns.
How To Write A Covered Call
Imagine you already owned shares of a company like Apple for example. When you sell a call option against your shareholding, you get paid a fixed amount of money over a specific time period. If the stock goes up, down, or falls you will always get to keep what is labeled the call premium. But why would anyone pay you a fixed amount of money over a specific time period in exchange for selling calls against stocks you own?
The answer to that lies in the obligation associated with a covered call strategy. When you sell a call against your share ownership position, you are contractually obliged to sell that stock at a fixed price. If you agree to sell your stock for $200 per share but the price rises to $220 by the expiration date of the option, it is your hard luck – you still must sell your stock at $200 per share.
Obviously selling a stock at a price lower than where it is currently trading seems like a bad deal, so why even consider a covered call strategy?
Why Write Covered Calls?
Any single covered call written may turn out to be a bad deal because you might get a small amount of call premium but lose out on a big advance in share price. If that was the only analysis you did, the strategy would seem to be worth skipping past. But over time, it can be highly lucrative, and here’s why.
More often than not, a stock will bobble about rising somewhat, falling a little, and meandering either higher or lower before reversing trend and often repeating a cycle. It’s not common for a share price to soar higher in a short time period, and then rocket higher next month, and the month after, and the month after that. For the most part, share prices settle into less volatile patterns.
And that’s where the covered call strategy is useful because over any given month you may have a bet that seems upside down: you could make maybe $1 in call premium but risk losing say $10 in share price gains. But if you take in that dollar in premium each and every month this quarter, next quarter, this year, next year, this decade, and next decade, well now you’re talking about some serious income!
The best way to think about the covered call strategy is not to myopically focus on any given month but rather to step back and analyze the benefits and costs over a long time period. And when you crunch the numbers you may be surprised to discover just how much potential it has to boost your retirement income from an existing stock portfolio.
If you already have a stock portfolio, there are lots of place online to figure out how much extra income you can earn. Any good covered call screener will accelerate the process of finding income-generating opportunities. Plus, if you already own stocks, you can quickly spot how much income potential is available to earn over a specific time frame.
Covered Calls Or Dividends
Research from Professor Jeremy Siegel at the Wharton School of the University of Pennsylvania has shown how reinvested dividends account for a massive portion of stock market returns over long time periods. If you already own dividend paying stocks, you are probably ahead of the curve when compared to most investors trying to earn income from their nest-egg. But don’t skip past covered calls in your search for yield.
While dividends are paid to you at regular schedules determined by a company, covered calls are paid to you according to a schedule you have much greater control over. Want to pay yourself a premium each week? Sell weekly call options against stocks you own. Prefer a hands-off investing experience? Sell LEAPS calls that expire way out in time often many months or even years into the future.
The bottom line is if you want to boost your retirement income, covered calls are a way to generate cash flow from your existing savings nest-egg and provide you more control over the timing of when you receive income compared to relying solely on dividend paying stocks.
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