Annuitize This

by: George Acs

I do essentially one thing and one thing only.

I try to use my stocks to create income streams from selling options. I try to make as many trades as I can through the course of a week, with each one adding just a bit more to that stream. I tend not to focus on the current share price or the paper gains or losses on the positions. I use the shares simply as a vassal.

That has worked nicely for me, not just in terms of performance, but in keeping me off the streets and allowing me to stop working at an age younger than I would have ever expected.

However, I do realize that my ability to have done so is to a very large degree also tied to the amount of funds that I have available with which to create that income. Those funds were accumulated over a number of years, but in hindsight I realized that there were so many missed opportunities. Not in terms of having owned the hot stock at just the tight time or having sold at just the right time, but rather in unlocking the potential to create option related income.

Ultimately, everyone can figure out for themselves how much they need to get to their destination and stay there until it's time to leave for that place where money has no value.

I also realize that there will come a time that I'm likely to get less interested in the minute to minute flow of data that I currently crave and I'm equally likely to begin focusing increasingly on safety, as well, with less use of speculative issues and specific portfolio hedges, such as Barclays Volatility ETN (NYSEARCA:VXX) or Direxion 3x Bull (NYSEARCA:FAS).

The reason that I do one thing and one thing only is because I'm not left with very much time to do anything else.

A past article of mine presented a turnkey retirement portfolio that was based upon assembling shares from a well defined universe of stocks and then selling options upon them. When assigned, there were guidelines for not only which stocks to use as replacements, but also how to decide between sectors in an effort to maintain diversification.

But even that approach required potentially tinkering on a monthly basis, which may still present an overly onerous responsibility for many.

A number of years ago, one of my sons did an internship with a well known insurance company. Among the things that I told him was that insurance sales was likely a very difficult career, as you are only as good as your stream of premiums coming from your sales. I also told him not to call any of his friends, their parents or our relatives in hopes of making sales.

Of course, he tried to sell me annuities. Of course, I said "No."

As another quick aside, a family friend has an aged parent with a sizeable portfolio that has been predominantly invested in income producing stocks and mutual funds. It was as "buy and hold" as you will ever see.

While the dividends were being re-invested, the portfolio holder was in need of funds for his mounting living and health related expenses. His broker had him use the margin in his account upon which to write checks for those expenses.

At the behest of the parent and his heir to be, I spoke with their broker and CPA in order to devise a mechanism to free them from the unnecessary margin interest expense. Dealing with the portfolio's in-house mutual funds that were notably underperforming was an issue for another time. The broker disagreed with my assessment, but my spread sheet was fairly objective

What fascinated me was when I mentioned the annuity that was in the account of this 88 year old individual. Its matured cash value more than covered a years' worth of living expenses. When I mentioned that as a logical source of funds, the broker actually tried to talk his client into getting a new annuity.

I don't like getting smoke blown into my face. Stock brokers aren't necessarily among my favorites. Neither are annuities.

Unless it's your stocks that are the annuity.

If you are of a buy and hold mentality or if you're not particularly interested in micromanaging your holdings on a frequent basis, why not reach a compromise and squeeze more out of your holdings with just the need for occasional tweaks on the schedule that you choose?

The key is selecting high quality companies that have a history of paying solid dividends and that also provide enticing option premiums.

During sideways moving markets, I happen to favor writing near the money options and accept the higher probability of assignment and the more frequent need to find suitable portfolio replacements. However, the annuity plan uses a very different time frame and strike price levels.

While I think nothing of holding a stock for just a week or a month, there's certainly nothing wrong with longer periods of time in an effort to also create capital gains on the shares. As my vassal, I really don't care too much about the stock's well being, as long as it can do the work of creating the income at an acceptable ROI.

The "Annuitize This" strategy is based upon an individual defining their Return on Investment on shares and then choosing an appropriate strike price for whatever length of time is preferred.

Do you like a one month period and the likelihood that you'll need to be replacing shares with frequency? Or do you prefer a longer term that not only provides larger premiums, but also less likelihood of assignment by someone in their effort to capture dividends from you?

The portfolio worksheet examines the returns of a 10 stock model portfolio and also provides alternative stocks as part of a well diversified approach to investing. (See the model portfolio)

For purposes of comparison, results can be seen for 1 month, 7 month and 19 month holding periods and are based upon closing prices on Friday June 15, 2012, the final day of trading of the June 2012 options cycle.

In essence, if you are a buy and hold investor, the "Annuitize This" approach allows you to lease your shares to someone else for a defined period of time. They pay you for that right, while you define the circumstances that the lessee can decide to move in for good.

The cornerstone stocks are in absolutely everyone's investing vocabulary, as long as you've heard of the Dow Jones Index or the S&P 500. Boeing (NYSE:BA), American Express (NYSE:AXP), United Parcel Service (NYSE:UPS), DuPont (NYSE:DD), British Petroleum (NYSE:BP), Microsoft (NASDAQ:MSFT), Philip Morris (NYSE:PM), Home Depot (NYSE:HD), Merck (NYSE:MRK) and Verizon (NYSE:VZ) are the first line stock selections.

All solid companies and with a history of reliable dividend payments.

Their alternates are equally well known. If a cornerstone stock is assigned it can be replaced by an alternate or from an alternate in another sector, particularly if that other sector hasn't shared in the same positive price moves as those of the assigned stock and its sector. Granted, moving to another sector may upset the objective or portfolio balance and diversification, but at the very next opportunity to rebalance, the diversification can be re-established, as sectors continually cycle in and out of favor.

As a caveat, the identification of these shares as part of this strategy is not an indication that I believe that they are currently appropriately priced for purchase. Individual investors should decide for themselves when a particular stock appears to be priced at a value that warrants purchase. Certainly, a portfolio as presented may be assembled over time.

For those who want the thrill of active trading, the monthly or even weekly time frame is possible. However, in that instance a relatively larger portfolio may be necessary to create the economy of scale that may be required in order to offset trading costs of option contracts. Additionally, if that economy of scale can't be realized, the investor may then choose to utilize strike prices that are more in line with the current share price. Of course, while that increases the premium received, it also increases the likelihood of share assignment.

For those with substantial enough portfolios to develop the economy of scale, squeezing option premiums on a monthly basis, even for out of the money strike prices can very easily accumulate over the year. Of course, by using the shorter term options, the investor may be less able to take advantage of profitably writing options if the underlying shares have had a short term downturn in their value.

Instead of continually reconfiguring your portfolio in an attempt to create income streams and attempting to navigate each and every gyration in the market, the longer term perspective offers several other advantages.

In addition to keeping trading costs down, the larger premiums inherently offset trading costs more effectively for smaller portfolios that can't develop the economy of scale. Certainly, there is also the intangible benefit of being freed of the concerns that are related to riding the waves and gyrations. Sometimes calm waters are really the place to be, even if you're a thrill seeker.

I'm not yet at that stage that I'll be moving to the "Annuitize This " approach, but it increasingly appeals to me as requiring so much less time and oversight. I'm just bothered by the fact that if I do make that transition, I'll either need to find a constructive replacement for my time or accept the fact that I've become so enfeeble or incapacitated that I had no choice.

But, as long as the profits keep coming, I can live, or be maintained in a vegetative state, with either of those scenarios.

Disclosure: I am long VXX.

Additional disclosure: At the time this article was presented for publication my shares in BA, BP and DD had been assigned the previous day. I may repurchase those during the coming week if prices fall to their previous strike price