Is Options Trading Wise In Retirement? Or are options not suited to retirement investing? And if options are suitable, what option trading strategies are best for retired investors? Which options spreads should be avoided by retirees? We investigate…
Options trading is perfect for retirement investing, if the right strategies, such as the protective put and the covered call, are used. However many other riskier strategies such as selling uncovered options, and complex options spreads such as the calendar spread, are less suitable as potential losses can be large and are complicated to manage.
Is Options Trading Wise In Retirement?
To answer that question, let’s first consider the most suitable investment types for seniors and older investors in retirement.
Risk Averse
Most financial advisors would say that an investor’s appetite for risk should decrease over time.
Younger investors can take on more risk, and potentially earn a greater return, as they have smaller balances to preserve and have more time to recoup losses over time.
As they get older, however, they will (hopefully) have a larger amount wealth to preserve and less time to ride out the ups and downs of risky investments.
Simplicity
It is unlikely that retirees would wish to invest in anything complicated or requiring significant additional learning. Hence, unless they had experience in an area the simpler the better.
(This is, of course, an over generalisation. Retirees have more time on their hands and might love to learn a new skill, such as learning how to trade options).
And so, does options trading pass these tests?
Well, thankfully options are one of the most versatile investing vehicles and there are several options trading strategies that meet these criteria.
Best Options Trading Strategies For Retirees
Protective (Or Married) Puts
A protective put involves buying a put option – giving the holder the right to sell the underlying stock – to protect an existing shareholding.
(A married or covered put is when the shares being protected are purchased at the same time, rather being already held. The following applies for these covered puts too).
So if a retiree has a portfolio of shares (or is buying one in the married put case) they can ‘insure’ against losses.
For example consider a retiree who could withstand a significant fall in their investments (20% say) without a change in lifestyle, but is concerned a larger stockmarket crash could affect their future quality of life.
The purchase of out of the money put options with an exercise price 20% below the market price could insure against this risk, at a reasonably low cost.
This is risk averse – it actually reduces risk – and is simple to implement. It does, however, come at a cost, albeit a small one.
Covered Calls
One of the simplest and most common options strategies is selling call options against existing stock positions.
This is slightly riskier than the above strategy as it shares could be ‘called away’ if they rise above the call option’s strike price.
However this can be mitigated by setting this exercise price at a significant premium.
For example suppose an investor holds 100 IBM shares currently trading at $100/share. The could sell a 3 month 110 call option, receiving a premium of, say, $5/share (or $500 in total).
Then, either IBM finishes below $110 in 3 months time, whereby the investor keeps the $500. Or it rises above $110, whereby the investor keeps the $500 plus sells their 100 shares at a 10% premium to the starting market price.
Zero Cost Collar
The above two strategies could be combined into a costless collar.
This is more complex – threatening to break one of our two criteria – but is a lovely way for a more sophisticated retiree to reduce the risk of a major fall in their share portfolio at no cost.
The strategy involves buying an out of the money protective put against their share portfolio, financed by the sale of an out of the money covered call.
The required insurance is obtained at no cost, with the only risk being missing out on a substantial share price rise (ie one over and above the call option’s strike price).
Options Strategies To Avoid
The options spreads to avoid are, as you’d expect, those that fail the two tests above. Namely, they are either risky, complex or both.
Uncovered Sold Positions
Writing call and puts without owning shares (calls) or having the cash to cover the position (puts) is very risky. In theory these positions could lose an infinite amount of cash. Avoid.
Credit Spreads
Less risky than uncovered options sales, credit spreads such as the bear put spread and bull call spread are still too risky.
Backspread Or Other Complicated Strategies
Backspreads and other complex trades are too complicated for our needs.
Conclusion
In conclusion then, options can form an valuable part of any retiree’s investment portfolio – but only if the right strategy is selected.
