How Stock Options Can Help Your Shrinking Nest Egg

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Stock options are increasing among investors with the volatility in the stock market. A call option gives you the right to buy a stock and a put option gives you the right to sell a stock. To see how to use these mechanisms, we turn to an expert on the topic, Steve Sears, President and COO option solution in New York

Larry Light: Options have grown in popularity in recent years. Why?

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Steve Sears: Since the global financial crisis of 2008 and 2009, investors have learned that volatility either happens to them or is something they can try to do something about. Puts and calls give investors the ability to do something other than be bounced by Mr Markets. This is a major reason why so many investors feel that options are no longer optional in their portfolios.

There is also another important reason, and it is not well understood. Many investors have learned – through hard experience – that what they were told by Wall Street to do has not turned out as expected.

light: How?

Sears: A large number of people have now gained significant first-hand experience of investing and are comparing what has happened with what they were told will happen. Remember, Wall Street’s embrace of Main Street is a relatively recent phenomenon that began in 1975 when fixed commissions ended and buying stocks was no longer prohibitively expensive for most people. The introduction of electronic trading and brokerage firms, which actually took place over the past 20 years, has helped bring Main Street deeper into Wall Street’s embrace. Even so, John and Jane Investor’s account balances often drop lower than expected.

This is one reason, as we discussed earlier, that so many people are not ready for retirement, and thus they are forced to hold more equity at an age when they should reduce risk. Now, as the Federal Reserve raises rates, and stock prices plummet, many people in and around retirement are extremely nervous as their nest eggs are shrinking.

light: Most people think that options are mostly used for aggressive speculation, not for the more noble ideals you support. What is disconnect?

Sears: The simple fact of that matter is that most people, and many journalists, understand aggressive speculation far more than responsibly investing. There is a financial literacy crisis in America that is often overlooked, and even less addressed, because it is difficult to treat and difficult to discuss. Furthermore, the meme-stock frenzy is more of a fascinating story than a piece on the importance of dividends to historical stock returns, or ways to reduce risk.

Also, we learned during the COVID-19 pandemic that America is a country of gamblers and bookmakers. People want to get rich fast. They always have and they always will be. An interesting take on the meme-stock phenomenon is that young investors, what I call millennials, tend to believe that options can be surrogates for stocks. Sophisticated investors have known for a long time, but it is unusual to encounter it in the general market.

light: fair point. What investors need to know and do if they want to exercise options responsibly.

Sears: Everything starts with stocks, and acting and thinking like a disciplined investor. Understand some key facts. Dividends account for about 45% of historical stock returns and inflation adds a few more percentages. So almost half the game of successful investing is making use of those facts and choosing a quality stock or fund and holding on to those investments. Don’t let the short term volatility in the market scare you into investing or investing. Be a long-term investor—yet with a potential twist.
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Options can help investors incorporate more discipline into their decision making. Investors can use options to buy low, or sell high and even reduce risk. In many instances, the money received from the sale of options may rival, if not more, than common stock dividends. None of this stuff is sexy, but it can be effective. Think of it as the equivalent of eating your vegetables and exercising.

light: It sounds to me like you’re essentially talking about building an investing discipline and using options to combine investment returns.

Sears: of course. I’m impressed by the disconnect that exists between Wall Street and Main Street, and the coverage of investing through the media and sell-side research—often obscures some of the simple things one can do to be more successful. If you read Warren Buffett’s investment papers, you will see that he always mentions compound returns, on the first page.

Options can be used to help investors do this. It’s more complicated than just reinvesting dividends, but not by much. If you understand your stocks and your investment goals, you can potentially generate significant income without complications by selling calls on your stock, or selling puts on the stocks you want to buy. Many retirees also use those strategies to generate income in retirement, to help keep their stocks compounded.

light: In other words, instead of simply buying a stock and expecting the price to move up over time, you are using options to create a compounding engine and another source of return.

Sears: This is right. The potential gains in compounding stocks in your portfolio come from the payment of quarterly dividends and collection of option premiums. Not all stocks will move forward, nor do all stocks pay dividends.

When a call is sold on a stock that investors own, the money received for the call can be treated as a “conditional dividend.” What is the dividend status? An investor must be willing to sell the stock at a higher call strike price, or to adjust the call to avoid assignment if they do not wish to sell the stock.

Should the stock price stay below the strike price, however, investors can reinvest the proceeds from dividends and option sales into more shares of the stock, which could eventually allow the sale of even more options. The process involves a discipline that attempts to secure profits by taking advantage of potential weaknesses in stocks — and many people are learning that stocks don’t always outperform — to buy more equities.

light: Sounds too good to be true. what’s the risk?

Sears: This investment method is not for everyone. This requires more attention, and there is usually a steep learning curve. There are risks, but those risks are defined. When you sell a put or call, you know the price at which you may have to buy the stock or sell the stock. You can also manage that risk, but Tradecraft is another topic of conversation.

I hope investors will remember from our talk that they can actively manage passive investments, they can define the risks associated with owning stocks, and they can use conservative options strategies to generate income. can do.

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