Using options to enhance a buy-and-hold strategy

— -- Q: Is there a way to use options to enhance a buy and hold strategy?

A: Some investors feel like the buy and hold strategy has taken them for a ride.

Buy and hold, long professed by academics and many large investment firms as the best way for investors to make money has been a difficult strategy to stick by the last decade. The idea of buying stocks and holding onto to them as they plummet into corrections, bear markets or worse, hasn't sat well with investors over the past 10 years. The strategy has been trying at best as investors sit through gut wrenching volatility only to earn next to no return on their investment.

Some investors, though, aren't willing to ignore decades of academic research showing how buy-and-hold investing can work. Instead, some are looking for ways to refine the idea of buy and hold so that it might work better for them.

And when it comes to ways to enhancing buy and hold, options certainly come to mind. Options are financial agreements that give buyers the right, but not the obligation, to buy financial assets at a prearranged time in the future at a prearranged price. While options can be used by speculators to make some wild bets, they can also be used prudently by investors who already own stock to boost their returns.

There are many ways to use options to dovetail with a buy-and-hold strategy and enhance returns. But one popular method is by selling a covered call. This somewhat basic strategy is a way for buy-and-hold investors, who may own a stock they're making money on and willing to sell but also willing to hang onto, to get some extra income.

Here's how it works. Say you own 100 shares of ABC. You paid $25 a share for ABC and it's currently trading for $30 a share. You like the company's prospects and think it could go higher and you don't necessarily want to sell. However, since you're up $5 a share, you wouldn't mind selling, either.

Since you're buying to hold anyway, you could sell a call to another investor at $35 a share. You will be paid for the call, giving you extra income you wouldn't have received had you just held the stock. If the stock stays below $35 a share, you just made free money. You pocket the price of the call option, effectively making money on a stock that hasn't budged or even fell.

But there is a risk to be aware of. If the stock takes off and shoots higher, you will miss out on the upside. By selling the call, you gave the buyer of the call the right to buy the stock from you at $35 a share. So even if the stock shoots to $100 a share, you must sell the stock at $35.

This is just one example of how options can be a benefit for prudent investors looking for ways to get a little kicker from a market that's been frustrating for buy and hold investors.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz