Naked and covered calls
Can you explain what “naked call” options are? — S.R., Mountain View, North Carolina
Sure. There are two main kinds of options: calls and puts. Buying a call gives you the right to buy a certain number of shares at a particular “strike” price within a set period of time (often just a few months). Buying a put gives you the right to sell shares.
When you sell (or “write”) a call, you’re committing to deliver a set number of shares if the buyer exercises the call. If you don’t own the underlying stock, that’s a “naked call.” It’s risky because if the stock soars, you may have to buy it at the new high price, to deliver it to whoever bought the call you sold. You might lose a lot. Of course, if the stock stays below the strike price until the option expires, you pocket the price of the option. That’s the appeal of this strategy.
“Covered calls” are safer, where you sell a call only if you own the underlying stock — and are willing to hand it over, if necessary. You won’t lose any cash this way, but if you have to relinquish your shares, you’ll miss out on profits you might have made if you’d kept the stock.
Many options strategies are risky. You can build wealth in stocks without ever using options.
Why does the stock market’s value rise or fall every day? — V.N., Tulsa, Oklahoma
The stock market is made up of thousands of companies’ stocks, and each rises or falls according to what investors think of it, based on the latest news or developments. Promising news usually sends a stock’s price up, and vice versa.
Stocks for your retirement
We often assume that as we approach retirement, we should sell many or all of our stocks and stick mostly with less volatile investments, such as bonds, certificates of deposit (CDs), money market accounts and cash.
That might be a mistake, though. It can be smart to keep a meaningful portion of your portfolio in stocks even when you’re retired. After all, if you retire at age 62 and you live to age 92, those are 30 years in which your nest egg could keep growing, and stocks offer better growth rates than bonds over most long periods.
You can aim for growth with the portion of your portfolio that you keep in stocks, while relying on the portion in safer investments to preserve your assets. For context, know that the stock market has averaged close to 10% annual growth over many decades — though with great variability from year to year, and no guarantees.
One old rule of thumb is to take the number 100, subtract your age, and invest the remaining portion in stocks. So if you’re 60, you’d park 40% of your portfolio in stocks, and 60% in bonds. With people living longer these days, some use a newer rule of thumb, subtracting their age from 110. That would put a 60-year-old 50% in stocks and 50% in bonds.
Another common rule simply suggests a 60-40 mix at any age, with 60% in stocks and 40% in bonds. But with interest rates having been very low for many years now, that hasn’t served many retirees well.
It’s best not to use any onesize-fits-all strategy for your portfolio, as everyone has different savings, incomes, risk tolerances, ages and expected longevity, among other factors. Take some time to try to determine your best allocation mix — one that will allow you to sleep well at night while still generating the income and portfolio growth required for the rest of your life. Don’t be afraid to consult a financial planner, either; you can find some fee-only ones at NAPFA.org.
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