Move over, meme-stock millennials. Your grandma wants to trade options.

By Beth Pinsker

Trading covered-call options on big stashes of stock can earn retirees extra income

Options-trading activity has been surging in recent years, but the picture you might have in your mind of bored millennials shorting meme stocks from their basements during the pandemic is a little out of the money, so to speak. These days, options traders are more likely to be retirees sitting on huge piles of Tesla (TSLA) or Apple (AAPL) stock who want to earn a little extra income from their concentrated positions.

With the run-up in the stock market in 2023 and at the start of 2024, especially with the so-called Magnificent Seven tech stocks, there are many people out there with increasingly concentrated equity positions. Advisers say some of this comes through inheritance, some through stock grants and some just because the stocks have collected over time.

"People in this position are left with a tough decision: Sell and pay taxes, or hold on and reduce concentration risk," says Dennis Huergo, a certified financial planner with the Wealth Enhancement Group, based in Warren, N.J.

With options, it takes two to tango. For every speculating buyer out there, there has to be a seller willing to put up their stock as collateral, and that's where retirees looking for income come into the picture. This symbiotic relationship has pushed options trading up greatly over the past six years, and up more than 6% in North America in 2023 alone, according to FIA, a trade organization for the derivatives market.

The top five options-trading stocks in 2023 were the ones you might expect, according to a report from the New York Stock Exchange: Tesla, Nvidia (NVDA), Apple, Amazon (AMZN) and AMD (AMD).

As a derivative contract, options are complicated and risky, and therefore not for the average investor. For one thing, to engage in options activity, you usually need special permission from trading platforms that shows you have enough investor education to do it safely. For another, you should be dealing with at least 100 shares for a round lot to sell or buy, and that can add up to big dollars. It's not generally profitable to do one-off trades or to treat it as a casual hobby.

"We hear all the things people say, like options are basically just gambling, but that's not all that options do," says Nick Griebenow, a chartered financial analyst and portfolio manager at Shelton Capital Management, based in Denver. "It's not all naked options and unlimited risk. What we're doing is conservative strategies."

Covered-call strategies

One strategy that many clients are doing is selling covered-call options on stock they already hold. This is the "safe" route, because the owner owns the underlying stock and basically uses it as collateral. They set the buying price above their cost and then collect a premium from the buyer. If the stock hits the target price, the deal goes through, and if not, the seller walks away with the premium. Do this enough times with enough underlying stock, and you make a steady profit with little downside.

"For those who may otherwise buy dividend-paying stocks or T-bills, writing covered-call options can be a great way to generate income in a more volatile market environment," says Scott Bishop, a certified financial planner at Presidio Wealth Partners in Houston. In today's market environment, he adds, "You tend to get more premiums for writing the calls, so that is even a better plus."

He says this strategy works particularly well with clients who have large capital carry-forward losses - meaning they took a hit in previous years and can take a tax deduction of $3,000 per year until the loss amount is used up. The options premiums generate short-term capital gains, which are typically tax-inefficient in a brokerage account, but they can be written off against the carry-forwards.

Specialized knowledge needed

This sounds easy enough, but it takes a lot of work to manage options - so much so that financial advisers like Huergo typically hire third-party options experts like Griebenow to do the actual trading. "I sit here and watch options chains all day long," says Griebenow. "I trade, manage and monitor covered calls all day. We have it down to a science here. For folks starting out trying to do it, it's a lot of work. For a lot of advisers, it doesn't make sense to do it themselves."

What the investor needs to watch out for is having their gains eaten up by fees. Huergo says the typical fee from a third-party options manager is about 0.50%, but it can be as low as 0.35%. Most advisers who offer this kind of service charge 1% of assets under management. So you only start to make a profit once you pay those fees.

"The goal is always for the client to make more money than they pay in fees, but it doesn't always work out that way," says Griebenow.

One thing that tends to gum up profits is that investors will write a covered call on their underlying stock, and then if the price shoots up and the contract is engaged, they get cold feet about actually selling their stock. It's a contract, so they have to, but then the options trader will go into the market and buy replacement stock or engage in another options contract as the buyer.

The other choice in that situation is to just have the trade go through and be satisfied with making a little profit instead of unlimited profit. As an example of this, Griebenow explains how an options deal worked out for him personally, in which he bought stock in a pharmaceutical company at around $6 a share. It was rising, so he wrote an option to sell it at $13. With a week to go before the options contract expired and he could walk away with the premium, a buyout offer for the company surfaced and the stock shot to $20. The contract was exercised at the strike price, and he missed out on about $7 in gain on each share.

"I would not have hit a glass ceiling if I didn't have the options, but instead I missed out on a few points. That's the name of the game," says Griebenow.

More from Beth Pinsker

I'm going to inherit $6 million in property along with my two siblings - is there a clever way to avoid capital-gains tax?IRA rollovers: What to watch out for - and how to avoid the sharksHere's how to find 'free' financial help even if you don't have $1 million-plus

-Beth Pinsker

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05-04-24 1247ET

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