Thinking Outside the Box to Counter Inflation
There’s no way to sugarcoat it: inflation is all around us. From groceries to gasoline to utility bills, everything is getting more expensive.
High inflation hits retired folks and others living off a fixed income especially hard. Due to higher prices, the same amount of dollars can buy less and less.
Inflation: Not Easy to Counter
Putting your money in the bank or buying CDs is safe, but you won’t earn much interest. In real terms (adjusted for inflation), your return will be negative.
You can buy bonds. Some bonds even adjust the interest they pay based on the inflation rate, but you usually have to pay a premium to buy them compared to bonds that pay a fixed interest rate. And during high inflation, the value of the bond typically falls, so if you had to sell the bond before maturity, chances are you will suffer a capital loss.
Even stocks, which historically have offered superior returns compared to bonds, as a group are in the red this year. Tech stocks, which have been big winners in recent years, no longer offer “easy money” because high P/E stocks usually don’t do well during high inflation.
Value stocks, especially ones that pay a safe and growing dividend, offer refuge. However, the highest quality stocks usually don’t offer particularly high yields—3% to 4% is a reasonable expectation. And unless the dividend growth is at least in the mid-to-high single digits, the dividend income probably won’t offset very much what inflation takes out of your wallet.
Of course, there’s real estate, which usually does offer protection from inflation. But you will need to have lots of cash to invest. Even if you do have the money, real-estate transactions take months to complete, so you won’t be able to pull your money out when you need it.
Using Options to Boost Income
It takes a little bit of thinking outside the box, but if you already invest in stocks and you are interested in boosting your income, you can consider using options.
You have probably heard that options are “risky.” They are indeed riskier than the underlying stocks in terms of how much and how quickly the price can change in percentage terms. However, compared to stocks, options require less money to trade and they are very flexible. Experienced traders often use various option combinations to manage risk.
Furthermore, options can be used to generate income by writing, or short selling, them.
Instant Cash “Dividend”
By selling a call option, you are selling to the buyer the right to buy from you 100 shares of the underlying stock per contract at the strike price at or before expiration of the contract.
Buy selling a put option, you are selling to the buyer the right to sell to you 100 shares of the underlying stock per contract at the strike price at or before expiration of the contract.
In both cases, the cash you receive for selling the stock is called the premium. That cash is yours to keep no matter what, and works effectively as a cash dividend. For a regular cash dividend, you have to wait until the company pays out the dividend on a predetermined date, but when you short sell an option, you get the cash right away.
If the underlying stock moves in your favor and the option expires worthless, then great, you are scot free. Keep in mind that there is a risk that the stock moves against you. In this case, you could decide to buy to close the position (even if at a loss) or just let the option exercise.
Factors to Consider
In the case of call writing, it helps to already have shares of the underlying stock. Selling calls against a stock you already owned is a covered call. The worst-case scenario here is that you are forced to sell the stock at a below-market price. So it helps to choose a strike price at which you would have been comfortable to sell the stock anyway. A covered call is less risky than a naked call (when you don’t have the underlying stock), which will require you to have the cash to purchase shares of that stock on the market in order to sell to the option buyer.
In the case of put writing, it helps to sell puts against stocks you like and pick a strike price at which you would have considered buying the stock anyway. This way, even if the put is exercised, you end up buying a stock you like at a price you thought was fair anyway (even if you paid above-market price).
Due to the potential volatility of options, it’s important to closely monitor and manage your positions. But by selectively and continually selling options, it’s quite possible to generate double-digit yields to help mitigate the corrosive effects of inflation.
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