The Hot Strategy to Hike Your Portfolio Payouts

Over the long haul, investing in stocks has brought huge gains to patient investors. But for those looking for additional income, there's a promising strategy that has gained in popularity recently.

Investors have struggled over the past year to find any way possible to preserve capital and avoid losses. Yet while no one wants to lose money, neither do you want to give up potential gains when the stock market rebounds. A strategy involving options, known as the buy-write strategy, gives investors the chance to earn some extra income from their portfolios while also retaining some of the upside if stocks rise.

How the buy-write works
As its name suggests, the buy-write strategy involves two trades. First, you buy shares of whatever stock interests you. Instead of simply owning the stock, however, you also sell a call option, giving someone else the right to buy those same shares from you at some point in the future.

Why would you buy a stock if you immediately decided to sell it to someone else? To answer that question, you need to look more closely at the call-option component of the buy-write strategy.

The option to profit
When you write a call option, whoever buys that option from you pays you a premium. That's money you get to keep, no matter what happens in the future.

When markets are particularly volatile, as they have been lately, the premium that investors are willing to pay you for the option you write can be quite substantial. For example, look at some call option prices for a few widely held stocks:

Source: CBOE.

Obviously, the opportunity to pocket 2-7% or more of the price you pay for a stock appears quite attractive, as it effectively reduces the net amount you have to pay to establish a stock position.

But as with most appealing investment strategies, there's a trade-off. In exchange for the premium you receive for writing the option, you risk having to sell your shares if they go up in price. And although you can choose an option that will give you at least part of the profits if that happens, the amount you receive for the option will go down for every dollar of profits you keep.

For instance, say you had bought Intel stock for its Friday closing price of $14.44. If you had written an option letting someone buy those shares from you for $15, then you'd have received $0.70. On the other hand, if you write a different option with a higher price -- say $16 -- then you'd only have gotten $0.36 per share in exchange for writing the option.

At first glance, you might think writing the first option makes more sense because it pays you more income. But if the stock price rises sharply before the option expires, then the difference is huge -- because you get an extra dollar more from selling the stock if you write the second option than you would from the first.

Why do it?
Obviously, the buy-write works best when:

• You want to own shares of a stock.
• You think it will hold its value over time.
• Even though it's attractive now, you don't think its price will rise too much between now and when the option you write expires.

In a sense, the buy-write gives investors a no-lose scenario: Either you get some extra cash to hold onto shares you already want to own, or you get paid an instant profit in a relatively short period of time.

As long as you're OK missing out on potentially huge gains, the buy-write strategy is a smart idea to consider. It boosts your income in down markets and locks in gains during bull markets. And it's a relatively simple introduction to all the various ways in which options can help you with your portfolio.

See these articles to learn more about:

• 3 investment myths you can't afford to believe.
• The one thing you need to beat the market.
• The easiest money you'll ever make.

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