Sunday, December 16th, 2018

How Should Retirees Trade Options

 

As investors enter retirement they typically adjust their portfolio to limit risk and guarantee a steady income stream with bonds and dividend stocks. Is there a place for options trading for the investor who is now retired? If so how should retirees trade options? There are two ways that retirees may wish to use options to their advantage in retirement. One is with covered calls and the other is with defensive puts.

For those unfamiliar with options trading just what are calls and puts?

A call contract gives the buyer the option to purchase the underlying equity which he will do if the equity price moves in the direction anticipated. A call contract confers an obligation on the seller (writer) of the call option to sell the underlying equity if the buyer executes the contract. Similarly a put contract gives the buyer the option to sell the underlying equity which he will do if the equity price moves in the direction anticipated. A put contract confers an obligation on the seller (writer) of the put option to buy the underlying equity if the buyer executes the contract. Covered options trading is when the seller of a call option or buyer of a put option owns the equity in question.

So, how should retirees trade options to their advantage, considering that in retirement they want to limit their risk?

Covered Calls

The first way for retirees to trade options, considering that they already own a portfolio of stocks, is with a covered call option.

A covered call option is when the owner of stock writes an options contract obligating him or her to sell stock at the contract price, the strike price, at a future date, the expiration date, if the buyer so chooses. The buyer of a call option pays a premium to have the option but not the obligation to buy stock in blocks of 100 shares per contract. The seller of a covered call option, or uncovered call option, is obligated to sell if the buyer exercises the contract.

The owner of a stock should have a good idea whether or not the stock he owns is likely to go up in price. When he owns a very stable stock he can not only collect dividends but also collect premiums with covered call options. This assumes that the stock will not go up in price. If it does and the buyer exercises the stock option the retiree still gets his premium as well as the contract price of the stock. He or she can never lose money with a covered call option although there is always the possibility that he or she will lose out on a stock price increase. More often than not the stock does not go up and the owner simply adds to his bank account.

Defensive Puts

This approach to options is also for retirees and applies to bull markets like today. You are very happy that one of your stocks is steadily going up in price but you also know from long experience that bear follow bulls like night follows day. A way to protect your position is by using puts to protect profits.

A good idea when you have a stock that has had a good run up is to use puts to protect profits. When the stock market has had a good run it is always time for the investor to look to protecting his profits. In fact, the old saying is that you do not have a profit unless you take a profit. There are two ways to do this. You can sell stock or you can use puts to protect profits. When the investor thinks that a stock still has a fair amount of upside potential but is also due for a temporary correction he can use puts to protect profits. Only when an investor thinks that a stock is entirely overbought and is due for a permanent fall in price will he sell stock and totally exit the position. Buying puts on a rapidly rising stock in a volatile market has been a successful strategy in long term investing over the years.

The most this strategy will cost a retiree is the premium paid to buy the put. The most it will possibly save is the a large fraction of the value of his stock position!

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