The annual inflation rate reached 9% in June 2022, marking its highest level since 1981. With interest rates rapidly rising, the Federal Reserve’s promise to further hike rates has discouraged investors from holding fixed-income securities. As a result, many income investors need alternative ways to boost their portfolio income.
Let’s explore how selling options can help boost portfolio income without the interest rate risk of conventional fixed-income investments.
Are Options Right for You?
Many stock option strategies are riskier than buy-and-hold strategies. For example, if a call option fails to reach its strike price, its value drops to zero. Options get a bad reputation since they can easily be used for leverage and speculation. We advise against these risky strategies and only recommend option strategies designed to generate portfolio income. Fortunately, the strategies we will cover are much lower-risk—in fact, they can even help you reduce overall risk.
Your retirement accounts may also have limitations in place. For example, many employer-sponsored retirement accounts may only have a few fund choices. You are out of luck with most 401(k)s or 403(b)s, but both IRAs and Roths permit low-risk options strategies, including those we’ll discuss. They only ban higher-risk strategies like short-selling, naked selling, and margin trading.
Lattco makes it easy to find and place covered call trades. Source: Lattco
Finally, options trading requires a more significant time commitment than buy-and-hold investing. For example, you need to research and identify opportunities each month and follow up with trades that go awry. Fortunately, we built some tools to streamline the process, including our Lattco trading platform that screens for opportunities and places trades.
Selling Covered Calls
Selling, or writing, covered calls is the easiest way to generate income using options. Using stock you already own, you sell a call option to another investor, agreeing to let them purchase the stock at the strike price. You then receive an immediate option premium that creates portfolio yield (e.g., the premium amount divided by the stock price).
Of course, that’s an oversimplification. Choosing the right option (e.g., strike price and expiration date) means researching your portfolio and analyzing options chains. Your goal should be to maximize the option premium while minimizing the chances of your shares getting called away. And if something happens, you may need to adapt on-the-fly.
The Snider Investment Method provides a done-for-you template for finding and managing covered calls. Our free e-course discusses the ins and outs of finding suitable stocks, selling the right options, managing your portfolio, and maximizing your income. We also look at what to do if the stock rises or falls in price and portfolio allocations.
OptionDash makes it easy to screen for opportunities. Source: OptionDash
If you’re already familiar with covered calls, you can use optionDash to spot opportunities quickly. The simple screener combines a proprietary scoring system with relevant data points to help you find the best covered calls. You can even create personal watchlists to track stocks while avoiding those with dividends, earnings, or other upcoming volatility events.
Selling Cash-Secured Puts
Cash-secured puts are another common options strategy to generate income. But instead of agreeing to sell a stock you own, you agree to purchase shares at a specific price. The strategy is “cash-secured” because you must have the cash set aside in your brokerage account to make the purchase—that way, it’s not “leveraged.”
The strategy works best when choosing a stock you’d like to own. For example, suppose that you like Coca-Cola as a business but believe that the stock is overvalued. You can write a cash-secured put where you agree to purchase the stock at a lower price. In the meantime, you earn an attractive yield on your cash (e.g., the premium divided by your cash).
As with covered calls, you must choose the right underlying stock and option to maximize income while ensuring that you’re actually willing to own the stock if the option is exercised. And if the underlying stock drops precipitously or something else unexpected happens, you need to adapt quickly to limit your potential losses on the trade.
In addition to covered calls, optionDash provides an easy way to spot cash-secured put opportunities. You can screen for stocks where selling put options provides a compelling yield. At the same time, you can ensure that the underlying stocks are high-quality companies with a compelling valuation to avoid buying bad companies.
Alternatives to Consider
Selling covered calls and cash-secured puts are some of the best ways to generate portfolio income without fixed-income securities, but they’re not the only way to generate income without resorting to bonds and other fixed-income securities. In many cases, investors use a blended approach to building a portfolio that generates income from multiple sources.
Some alternative ways to generate an income include:
- Dividend Stocks – Dividend stocks provide a steady source of income, although it’s typically a much lower yield than bonds. Many investors use covered calls and cash-secured puts on top of dividend stocks to maximize their income.
- Covered Call ETFs – Covered call ETFs provide a hands-off way to generate income from covered call strategies. While the income is often lower than a do-it-yourself approach, it may be better for investors that don’t want to invest time and effort.
- Preferred Stock – Preferred stock usually offers a dividend that’s higher than common stock, along with liquidation preference and other benefits. Like covered calls, there are also preferred stock ETFs offering exposure to these sources of income.
- I-Bonds – Series I Savings Bonds provide inflation adjustments, meaning they currently offer a ~9% yield to investors. However, these interest rates reset every six months, meaning that they could move lower as inflation recedes. They also have strict annual purchase limits. At only $10,000 per year, they won’t make a significant dent in most investors’ portfolios.
The Bottom Line
Inflation reached its highest level since 1981, while the Federal Reserve’s plan to hike interest rates is taking a toll on fixed-income securities. As a result, investors seeking alternative ways to generate portfolio income may want to consider covered calls or cash-secured puts. These low-risk options strategies offer a compelling income boost.
If you’re new to options, the Snider Investment Method provides a time-tested way to find and execute these trades. Take our free e-course to learn more or inquire about our asset management services for a hands-off approach.