All investments, apart from bank accounts — up to £85k — and government bonds issued by reputable countries, carry some level of risk. And as we saw in the financial crisis, even your bank account is not quite as safe as you maybe thought.
Risk and reward go hand in hand. The higher the potential reward, the higher the potential risk. If you ever find an investment that breaks that rule, you should bet the farm.
But, to answer the question with regard to this strategy: The risk is in the underlying shares, not in the options we sell.
The FIRE Revolution strategy focuses on the biggest most boring blue-chip companies you can imagine. Companies such as HSBC, GSK, Sainsburys, Severn Trent, BP and United Utilities. They are all stalwarts of our everyday lives and usually pay decent well-covered dividends.
Now, of course, their share price goes up and down over time, but do you really think any of them are going bust any time soon? No, neither do I.
And here is the clever bit. By selling options on these shares, you are bringing in immediate cash flow that can offset any unrealised drop in the price of the shares. Depending on how long you sell the options for, this can add up to quite a sizeable pot. So, the strategy actually reduces the risk of simply owning these shares outright.
But I will stress that there is still a risk. Even big blue-chip shares can get into trouble and sell off quite hard. Do you remember what happened to BP shares after the Deepwater Horizon disaster in 2010? If not, go and have a look at a stock chart for that period. Ouch.
But here’s the thing. Not to undermine the environmental impact or the loss of human life, but look at the BP share chart for the years that followed. What felt like a financial disaster for the shareholders at the time, looks like a bump in the road when viewed ten years later.
And the key point is that as income investors we are far more focused on the dividends and option premiums than regular ‘buy and hold’ investors. If we are still receiving income then we can easily ride out the short term volatility of share investments.
There is always risk in owning shares — or indeed any other asset — but as long as the company doesn’t actually go bust, the price usually recovers over time. The trick is to try and pick the right stocks in the first place and then not panic at every downturn.
Big-yielding blue chips are usually amongst the safest stocks you can buy and by selling options on them you are reducing the risk even further.