The stock and bond markets experienced significant volatility in September, with the S&P 500 declining 0.5% due to rising oil prices, increasing Treasury yields, and concerns about further Federal Reserve rate hikes. The 10-year Treasury yield reached a 19-year high, and the 30-year yield surpassed 5.6%, its highest since 2002. While not a substitute for core income-generating assets like bonds and dividend stocks, options strategies can offer a valuable supplement to a diversified portfolio.
According to Ashton Lawrence, a certified financial planner and director at Mariner Wealth Advisors, many investors are feeling uneasy about the market. "We're taking your current portfolio and trying to use options to generate additional cash flow, establish positions more deliberately and put some guardrails around risk," he stated.
Covered Calls: Generating Income from Existing Holdings
For investors looking to enhance their income, covered calls present a popular entry point. Joe Mazzola, head trading strategist at Charles Schwab, explains that this is often the first income strategy people implement. A call option grants the holder the right to buy shares at a specific price by a certain date. With a covered call, an investor who already owns the underlying stock sells a call option against it. If the stock price remains below the strike price, the option expires worthless, and the investor keeps the premium. However, the investor must be prepared to sell their shares at the strike price if the stock rises above it.
Mazzola suggests writing covered calls on stocks that have appreciated significantly, particularly those in AI-related sectors. "You might be sitting in a range where you haven't seen that upside push lately, and you could sell out-of-the-money calls to augment those returns," he advised. The drawback is that investors may miss out on substantial upside if the stock price surges well beyond the strike price.
Cash-Secured Puts: Getting Paid to Wait
For those aiming to earn income while waiting for a more opportune entry point into a desired ETF or stock, the cash-secured put strategy can be effective. Lawrence observed a notable amount of cash sitting in money markets, indicating investor hesitation. "Here's how we can get paid to wait for that lower price point," he remarked.
A put option provides the right to sell a stock at a specified price by a set date. When selling a cash-secured put, the investor receives a premium upfront but must set aside enough cash to purchase the shares if the stock price falls to the strike price. Crucially, Mazzola emphasizes that the underlying stock should be one the investor is comfortable owning at the strike price: "The key with the cash-secured put is to make sure this is a stock you want to own at that price. You might get tested at that expiration cycle." The primary risk is a sharp decline in the stock price below the strike price. Alternatively, if the stock rises and never drops to the strike price, the investor keeps the premium but forfets the opportunity to buy the shares at the desired price.
Understanding the Risks
While options can potentially enhance portfolio performance, they also introduce an element of risk. "If you're trying to do it yourself, understand what you're doing and why you're doing it," cautioned Lawrence. He likened options to fire: "You can use fire to heat your home and be comfortable, but you can use that same fire to burn down that home and have nothing left."
