Best Option Trading Strategy for a Portfolio Paycheck

  by Shelley Seagler

There’s an option trading strategy that’s practically a hidden reservoir of monthly income generation lying in your own investment portfolio’s proverbial ‘backyard.’

Becoming aware of this strategy and learning how to use it empowers you to start generating real income from your portfolio, quickly.

While you may not have known about this great opportunity to put your portfolio to work, increasing numbers of investors are using this option trading strategy – and thousands of our clients have used it for years – to generate more income,  and experience less volatility in their portfolio.

The option trading strategy I’m referring to is ‘Selling Covered Calls’

Learning how to sell covered calls to generate portfolio income may be a game-changer for you.  Even better – it can be a big key to more income in retirement, which is exactly when you need it the most.

Because of the power of selling covered calls, it’s a critical component of the Snider Investment Method.

Don’t miss: 5 Tips for New Covered Call Writers

Selling Covered Calls is Critical to Building Wealth

While most people define wealth simply by looking at the sum total of their stock investment portfolio, the more meaningful number is the withdrawal rate you’re able to take to pay your bills in retirement.

In other words, if you were able to generate a monthly paycheck from your portfolio for thirty years in retirement and still have a nest egg to pass on to your children, wouldn’t you consider that to be real wealth?

Of course you would!

That is why we believe the #1 Job of your portfolio is to produce a paycheck.

Income replacement is the goal of retirement planning. So then, for investors who are in, or nearing, retirement, this must be the objective of your portfolio.

The Snider Investment Method has 2 critical goals it strives to achieve through the use of stock investing, options trading and cash management techniques.

  • Goal #1 – Generate 1% yield from your stock portfolio, on average. If you’re still working and don’t need the income, simply reinvest the income to benefit from compounding growth.
  • Goal #2 – Avoid any permanent loss of capital through our strict, proven set of rules that help you control emotional reactions to market changes and simple stock selection process.

Usual Suspects: Traditional Income Investment Options

Traditional sources of investment income include: Bonds, CDs, Dividends, Money Market Funds, Treasuries, Real Estate and insurance products – like Annuities. What do all of these products have in common?

It’s that, unfortunately, they just don’t pay very much.

And, likely, there is a good chance none of these will enable you to survive through what could very well be a pretty long retirement,which is why you need a better plan for income replacement.

So What’s a ‘Call’ Anyway?

A call is an option contract that gives its owner the right, but not the obligation, to buy a stock – at a specified price – which is called the strike price, on, or before, a specified date. This date is called the expiration date.

When you buy a call – you have the right to buy a stock. People who buy calls are considered bullish. They’re betting that the price of the underlying stock will increase substantially before expiration.

But for every call that is traded, there’s both a buyer and a seller.

When you sell a call – you are obligating yourself to sell shares.

So what’s the primary benefit of selling something rather than buying it? It’s that instead of spending money – you receive money!

Types of Calls

There are two types of calls. First there are naked calls. When you sell a naked call you are obligating yourself to sell shares of a stock that you do not own.

Selling naked calls is incredibly risky. People often automatically think risky when they hear about options.  Naked calls  is a highly speculative strategy.

But options don’t have to be risky and can used to reduce the risk in your portfolio.  So the second type of call, the one that can be appropriate for a wider range of investors, is known as a covered call. With a covered call – you do own the underlying stock.

This is one of the safest, easiest to use, and most popular types of option strategies used by average investors.

Covered Calls Have Become Super-Popular

Since their introduction in 1973, standardized equity options (calls and puts) have become incredibly popular with over 15 million puts and calls trading hands every day. Since each represents 100 shares, those options control the equivalent of 1.5 billion shares each day.

But, as I said, the most popular option choice is the covered call position.

One Wall Street Journal reporter writes, “Covered calls are so popular that 84% of investors who trade options at Charles Schwab & Co. are using covered calls these days. That means over 4 out of 5 people using options are specifically using covered calls.”

Selling Covered Calls to Generate a Paycheck

You sell a call against the shares you already own. When you sell that call, 2 things happen.

  • First, you are obligated to sell your shares at the strike price on, or before, the expiration.
  • Second, you will receive what’s called  option premium, which is simply what you’re paid to sell the call. You get to keep that premium  regardless of the expiration outcome (whether the call buyer exercises their right to buy your shares or not).

The great thing about this option trading strategy is that you can apply it to stocks you already own.

Benefits and Risks of Selling Covered Calls

BENEFITS: The benefits of selling covered calls are pretty straightforward.

  1. You can generate a monthly paycheck when you sell calls on a routine, monthly basis – as our clients do.
  2. You may increase the yield on your investment. In other words, you can add additional income by selling calls on stocks in your portfolio.
  3. Experience less market volatility, option premiums can offset some or all the price declines when your stocks drop in price.

But don’t just take my word for it.

Callan Associates evaluated an index that used Covered Calls with the S&P 500 for an 18 year period and found that the index that used Covered Calls not only outperformed the S&P over the 18-yr period but it also experienced less volatility.

In another study, two PhDs, Keith Black and Edward Szado  analyzed 119 mutual funds, some of which have been using options since 1988. They found that these funds experienced higher returns with lower volatility swings than the S&P 500.

The good news is, with just a little investor education, you can sell covered calls on your own!

RISKS: Now let’s look at the risks.

The biggest risk is stock ownership. If a stock you own drops in price or God forbid goes bankrupt, then you could lose a considerable amount.  Of course, this is true with all stock market investments.

And since most of our clients are either in retirement or are gearing up for it – stock selection is crucial for us. We use very rigid parameters to select stocks for the Snider Method. Your guidelines for choosing stocks should be rigorous too. Just like us, you want to make sure you’re getting the best possible stocks for your strategy.

The second risk you should really think about is that covered calls can actually limit your upside potential. Think about it, you’re locking yourself into selling at, say, $60 per share regardless of what that stock was trading at. It could be trading at $65 – it doesn’t matter, because your obligated to sell at $60.

Your Next Steps

You’ve taken a sneak peak at one of the best option trading strategies used today to generate income from your portfolio. We’ve defined what selling a covered call is, what it does, it’s benefits and risks, and why it’s a great move for increasing your portfolio income in retirement. Whether you’re a complete beginner, or experienced investor, you can learn this option trading strategy, relatively easily and quickly.

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