Maybe just a crazy idea, but someone else has likely had the same crazy idea before and either implemented it or ruled it out. At any rate, this post is just meant to generate discussion.

Assume that in retirement you are holding some stocks and some bonds, and you have a policy to rebalance if the proportions move out of some pre-determined range. (I appreciate that not everyone follows this policy, and the discussion that follows will not be terribly interesting to those who don't own bonds and also rebalance.)

The basic idea is pretty straightforward. It entails writing puts and calls that trigger transactions you would make to rebalance, even without the options on the table. For example, let's say I plan to buy shares of GE if the price drops to 25 (selling bonds that I already own to fund the purchase). Rather than just waiting to see if the price drops that far, I could write a put option and collect a premium while I wait. If I wrote a Jan10 LEAP at 25 today, I'd collect a premium of 200 dollars that adds to my current income. (This is not a covered put, so I believe it would be disallowed in an IRA account).

Additionally, I might decide to sell 100 GE shares that I already own if the price were to hit 45. I could write a covered Jan10 LEAP today and collect another 60 dollars for this contract. This is a covered call, which I believe is allowed in IRA accounts. Of course, there will be commissions to pay with every transaction, and these commissions will detract from the net income received.

It the options are written reasonably far out of the money, most of them will expire without being exercised. At that point one is free to write another set of options. And of course, instead of writing options on individual stocks, one could write them on indexes or ETFs (e.g., SPY).

I estimate that this could generate a few tens of basis points annually, maybe $1000-$2000 on a half-million dollar portfolio.

The main downside I see is that, in the event of a huge market move (like Oct 1987) one could be forced to rebalance at a less advantageous price than if the options had not been used. For example, if GE dropped to 20, I would still be forced to buy the shares at the 25 price I agreed to in the LEAP contract.

Observations? Comments?

Duane