S&P500 Plus Index Options for Principle Maintenance

I’m going to take a look at another variation on the theme of putting principle in an S&P500 ETF (like SPY) and living off of the dividends and principle appreciation.  In another analysis I included the affects of using some of the annual payout to purchase index options, to see if that would increase average payout (it did over the study period, but at the expense of significant annual variability in payout).

In this analysis the payout will be held constant, like it was in this analysis, and some of the remaining principle each year is used to buy index call options.  Rather than the proceeds from the index call options being used as additional payout, however, it’s used to augment the principle, with a goal of the principle lasting longer.

Specifically, the analysis is for:

  • Constant inflation-adjusted payout each year of 3%, 4%, 5%, or 6% of the initial principle balance
  • 3% of the initial principle balance is used each year to purchase a 12-month SPY index call option
  • The amounts shown assume an initial investment of $100k in 2016 dollars

For example, suppose a 4% withdrawal rate is used.  This means $4000 is taken out each year as payout (per $100k invested).  In addition, $3000 is taken out (per $100k invested) of the principle each year and invested in index call options.  The proceeds from the index call options at expiration, if any, are put back into the principle balance for the next year.

This chart shows the principle balance for each withdrawal rate over the study period:

Since none of the withdrawal rates completed depleted the principle balance within the study period, each inflation-adjusted payout was constant for the entire study period ($3000, $4000, $5000, or $6000, depending on payout rate).

For reference, here is the chart of principle balance for each withdrawal rate without investing in index call options:

At the end of the study period, the principle balance was higher with purchasing index call options than without:

  • 3% payout: +6.3%
  • 4% payout: +7.3%
  • 5% payout: +8.5%
  • 6% payout: +10.4%

That does not mean augmenting principle with index call options is without risk.  In 2012, the principle balances were lower with purchasing index call options than without, but the subsequent rise in the stock market made up for it:

  • 3% payout: -6.2%
  • 4% payout: -6.8%
  • 5% payout: -7.3%
  • 6% payout: -8.1%

 

This is an analysis of past performance, but past performance is not a guarantee of future performance.

Comments / Questions: joseph AT StockMarketMovement.com