A Smart Strategy for Cash-Starved Investors

With the economy still struggling, many investors are having to turn to their investment portfolios for money to cover living expenses. Especially among retirees, Social Security's coming pay cut means your investments have to work harder to make ends meet.

So what's the best way to get that income? There are some simple ways to take cash out of your portfolio that most income-seeking investors use on a regular basis. But if you need bigger payouts, then a less obvious yet equally simple strategy can give your income a much-needed extra kick.

Going beyond the obvious
Investors commonly use two popular methods to get income from their portfolios. First, they typically use an asset allocation strategy that includes fixed-income securities like bonds and bank CDs. Although those investments aren't designed to grow, they do provide a predictable stream of income that you can depend on no matter what happens to the stock market.

Second, many retired investors gravitate toward including more dividend-paying stocks among their stock portfolios. Especially now, with reputable companies like Verizon (NYSE:VZ) and Altria (NYSE:MO) paying dividend yields of more than 5%, dividend stocks can go a long way toward helping you cover your cash needs.

But even with these two methods, you may still find yourself facing a cash shortfall. The following are some common situations where you might find it more difficult to make your portfolio give you the income you need:

• Big gains on long-held stocks. If you've used a buy-and-hold strategy, you may have many stocks that have accumulated large gains over the years. If those companies don't pay dividends, however, you're kind of stuck, as selling them to buy other investments will force you to pay a large capital gains tax.
• Your investments are IRA-heavy. Many people have a huge fraction of their assets locked up in tax-deferred accounts like IRAs and 401(k)s. Although that's great when you're saving money, relying on traditional retirement accounts means that anytime you need to take withdrawals, you incur more taxes. As a result, you may want as much income as you can possibly get from your regular accounts, so that you can postpone tax on your retirement-plan withdrawals as long as possible.

Enter options
Fortunately, there's another way to generate portfolio income that addresses these concerns. The Fool's Rule Your Retirement newsletter service recently included a discussion of this issue, as lead advisor Robert Brokamp chatted with Fool options expert Jeff Fischer.

One of the strategies Fischer discussed for income-seeking investors was to use covered call options. With the covered call strategy, you sell call options against shares of stock you already own. When you do so, you get paid a premium that you're entitled to keep no matter what happens with the option. In exchange for that premium, the investor who bought the call option has the right to buy your shares at a specified price.

Depending on the length of the option and where the stock's price is in relation to the price specified in the call option, the covered call strategy can generate significant additional income without huge risk, even with stocks that don't pay dividends. Here are some examples:

Source: CBOE. Closing prices as of Sept. 17.

With those option premiums representing an extra 3% to 8% of the stock price in your pocket -- often for just three to five months of option exposure -- you can see how covered calls can really help boost your income.

That income doesn't come free, though. If your stock rises above the price specified in the call option, then you'll have to sell your shares. In the above examples, though, the shares would have to rise further between now and when the option expires before your buyer would exercise the option. So when you're picking an option, be sure to choose one that won't disappoint you if you have to sell your shares.

Weigh your options
The covered call strategy adds another weapon in your income-generating arsenal. It's not an obvious move, but used correctly, covered calls can help you make the most from your investments.