Long-term buy and hold investing has turned many investors into millionaires over the years. But once you've made your fortune from the stock market, the biggest challenge still awaits retirees and near-retirees: how to turn those highly appreciated stock holdings into cold hard cash, without paying an arm and a leg to the IRS. Fortunately, there's a way you can reap income from just about any stock, without triggering huge tax liabilities.

You wish you had this problem
Unless you're one of them, it's hard to feel sorry for winning investors who've made millions from smart stock picks. For those who started investing in the 1970s and early 1980s, successful stock investing was almost as simple as just picking whatever stock you wanted, and then watch it rise steadily over the decades. By now, many of those investors are sitting on some huge gains, and in many cases, their stock portfolios may well make up most of their entire net worth.

But if you're retired or near retirement, and you hold your winning stocks in regular taxable accounts, you now face a dilemma. As you age, you want to start thinking about drawing income from your investments. But many top-returning stocks over the long haul don't give you any dividend income at all. So if you hold onto those stocks, then you're stuck with a lot less income from your portfolio than you need.

On the other hand, if you sell those big gainers to diversify into investments that produce more income, you'll face an immediate haircut from the IRS. Sure, the renewal of the 15% maximum tax rate for long-term capital gains through 2012 makes selling stocks a lot more palatable than it would have been if the tax cut extension hadn't gone through. But with the amount of money at stake, even 15% can amount to hundreds of thousands or even millions of dollars.

The better option
Luckily, you can take advantage of another strategy to generate portfolio income. By using the covered call option strategy, you can collect income by writing call options against stocks that you already own. In exchange, you'll receive a premium that's yours to keep no matter what happens.

The option gives whoever buys it from you the right to buy your shares at a predetermined price, called the "strike price." So when you write options, you run the risk of having your shares called away. But many options never get exercised, because the stock never rises above the strike price -- in which case you'll pocket the entire premium as profit.

As an example, I looked at the top returning large-cap stocks of the past decade that don't pay dividends. Here's the list:

Company

Stock Price

Call Option for Covered Call Strategy

Premium Received Per Share

Premium as % of Stock Price

Southwestern Energy (NYSE: SWN) 38.48 June $45 0.83 2.2%
Apple (Nasdaq: AAPL) 341.40 July $400 8.30 2.4%
priceline.com (Nasdaq: PCLN) 428.86 July $500 18.30 4.3%
Intuitive Surgical (Nasdaq: ISRG) 330.93 July $400 5.00 1.5%
Cognizant Technology (Nasdaq: CTSH) 73.35 July $85 1.75 2.4%
Express Scripts (Nasdaq: ESRX) 57.34 May $65 0.81 1.4%
AutoZone 248.70 June $280 4.50 1.8%
Gilead Sciences (Nasdaq: GILD) 38.16 May $42 0.79 2.1%

Source: Yahoo! Finance. Prices as of Jan. 25 close.

As you can see, those option premiums represent between 1% and 4% of potential extra income, for less than six months of option exposure. If you repeatedly use this strategy, you can bring in a nice income yield regularly, even on a stock that doesn't pay a dividend.

Of course, there is a potential downside. If the stock rises above the strike price of the option you choose, then you'll either have to sell your shares or buy back the option at a possible loss. In the examples above, though, the stock price would have to rise significantly between now and when the option expires before your buyer would choose to exercise the option. That extra appreciation would in many cases be enough to cover the extra capital gains tax liability.

Pick the right choice
Using covered calls doesn't solve all the problems you have as an investor. But as a way of pulling income out of winning stocks that don't pay dividends, it has some definite advantages.

If you don't already have huge winners in your portfolio, get the income you need from dividend stocks. Find the best ones in the Fool's free special report, " 13 High-Yielding Stocks to Buy Today ."

Fool contributor Dan Caplinger is always looking for ways to get more cash. He doesn't own shares of the companies mentioned in this article. Intuitive Surgical is a Motley Fool Rule Breakers pick. Apple, Gilead Sciences, and priceline.com are Motley Fool Stock Advisor choices. The Fool owns shares of and has written puts on Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy gives you something worth more than money.