Think outside the box to counter inflation

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There’s no way to water it down: inflation is all around us. From groceries to gas to utility bills, everything gets more expensive.

High inflation hits retirees and other people living on fixed incomes particularly hard. Due to higher prices, the same amount of dollars can buy less and less.

Inflation: not easy to counter

Putting your money in the bank or buying CDs is safe, but you won’t earn much interest. In real terms (corrected for inflation), your return will be negative.

You can buy bonds. Some bonds even adjust the interest they pay based on the rate of inflation, but you usually have to pay a premium to buy them compared to bonds that pay a fixed interest rate. And during high inflation, the bond’s value typically drops, so if you were to sell the bond before maturity, chances are you’d suffer a capital loss.

Even equities, which have historically offered higher returns than bonds, are in the red this year. Tech stocks, which have been big winners in recent years, no longer offer “easy money” as high P/E stocks generally don’t perform well in times of high inflation.

Value stocks, especially those that pay a safe and growing dividend, offer a safe haven. However, the highest quality stocks generally don’t offer particularly high returns – 3% to 4% is a reasonable expectation. And unless dividend growth is at least in the mid to high numbers, dividend income probably won’t make up much for what inflation is taking out of your portfolio.

Of course, there’s real estate, which generally provides inflation protection. But you will need a lot of money to invest. Even if you have money, real estate transactions take months, so you won’t be able to withdraw your money when you need it.

Use options to increase income

It takes a bit of thinking outside the box, but if you are already investing in stocks and want to increase your income, you may want to consider using options.

You’ve probably heard that options are “risky.” They are indeed riskier than the underlying stocks in terms of how much and how quickly the price can change in percentage terms. However, compared to stocks, options require less money to trade and they are very flexible. Experienced traders often use various combinations of options to manage risk.

Additionally, options can be used to generate income by selling them or shorting them.

Instant cash “dividend”

By selling a call option, you are selling the buyer the right to buy from you 100 shares of the underlying stock per contract at the strike price no later than contract expiration.

To buy by selling a put option, you sell the buyer the right to sell you 100 shares of the underlying stock per contract at the strike price no later than contract expiration.

In either case, the money you receive for selling the shares is called the premium. This money is yours no matter what and effectively functions as a cash dividend. For a regular cash dividend, you have to wait for the company to pay the dividend on a pre-determined date, but when you short sell an option, you get the cash immediately.

If the underlying stock moves in your favor and the option expires worthless, then great, you’re free. Keep in mind that there is a risk that the stock will move against you. In this case, you can decide to buy to close the position (even at a loss) or simply let the option exercise.

Factors to Consider

In the case of writing call options, it helps to already have shares of the underlying stock. Selling calls against a stock you already own is a covered call. The worst case scenario here is that you are forced to sell the stock at a lower price than the market. It is therefore useful to choose a strike price at which you would have been comfortable selling the stock anyway. A covered call is less risky than a naked call (when you don’t have the underlying stock), which will require you to have the money to buy shares of that stock in the market in order to resell to the option buyer.

In the case of writing put options, it helps to write put options against stocks you like and choose a strike price at which you would have considered buying the stock anyway. This way, even if the put option is exercised, you end up buying a stock you like at a price you thought was fair anyway (even if you paid above market price).

Due to the potential volatility of options, it is important to monitor and manage your positions closely. But by selectively and continuously selling options, it is entirely possible to generate double-digit returns to help mitigate the corrosive effects of inflation.

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