Why would I compare a safe account at a credit union to a “risky” account on the options market? Because we all need to earn yield while our money sits still.
Although certificates of deposit and the options wheel offer two different spectrums on the risk scale, they both serve the same goal: to earn interest and grow our pot of money.
Let’s compare the two and discuss why you could potentially leverage them both together to offer safe and growing returns.
What is Decentralized Finance?
What is a certificate of deposit? A certificate of deposit (CD) is a promissory note from the bank to you in exchange for locking up your money for a specific time.
In other words, you are loaning the bank money to gain interest. It’s pretty simple, but there are some nuances you should know.
First, certificates of deposit from banks and credit unions offer FDIC protection, giving you an additional layer of safety against bank runs during a recession.
However, taxes are a major issue with certificates of deposit because they offer no tax shelter. That means that the federal and state governments will tax your interest at your personal tax rate—not fun.
Most people I know who use CDs do so because they only trust their institution. There are better places to park your money that will reduce your tax burden.
Decrease Possessions. Increase Wealth.
However, if you don’t trust online banks (high-yield savings), the federal government (Treasury Bills), or the stock market (tax-free money market funds), then CDs are your only and best option.
Let’s do some math. Say we have $100,000 to invest in a CD through Navy Federal, which is offering a 12-month CD at 5.5%.
After the year, we will have earned $5,500 in interest. The key to succeeding with CDs is to use a high-yield reinvestment strategy. This means to reinvest your $5,500 into high-yield products that keep growing your wealth and generating income (closed-end funds come to mind).
If we reinvest the $5,500 at 10%, we now have a dividend portfolio that pays us $5,500 per year or $458 monthly. The best news is that our initial $100,000 is safe and sound.
The magic of the Options Wheel. On the other end of the spectrum, far outside of a bank account, is the Options Wheel. The Options Wheel consists of selling covered calls and cash-secured puts inside an infinite loop.
Life in the Metaverse
The key to the Options Wheel is that we can generate the same 5.5% rather quickly and use that money much earlier in the year.
The Options Wheel starts with selling cash-secured puts against our pot of money. A cash-secured put simply says we will purchase 100 shares of a stock if its share price falls below a certain level.
So, let’s set up our options trading portfolio using the same $100,000. We won’t need the entire $100,000 to play the Options Wheel, so we can set aside $60,000 in a money market fund earning 5.5%.
Operating with my rule of 40, we can aim for $1,000 per month in options wheel income. My rule of 40 stipulates that you multiply your estimated monthly options income by 40 to get your options trading portfolio amount.
Content Creation in the Metaverse
Therefore, if we have $40,000, we can divide that by 40 to arrive at $1,000 monthly. Now that we have our parameters, we can sell some cash-secured puts on Rivian (RIVN).
Rivian’s current stock price is $14.13, so we can sell a cash-secured put at the $13 strike price and earn $53. To sell one cash-secured put, I would need to have $1,300 in my cash reserves in my portfolio.
To generate $1,000, I would need to sell 19 cash-secured puts. I wouldn’t recommend selling that many at once, but let’s do it for this example.
To sell 19 RIVN cash-secured puts at the $13 strike price, I would need to set aside $24,700 in my cash position. This would generate $1,007 in cash flow.
Dividends vs. Royalties III
I would trade these RIVN puts for as long as possible until, finally, someone exercised their options and gave me 1,900 shares of RIVN. From there, I would trade covered calls against my RIVN position.
Because I want to get rid of these shares, I can sell covered calls at the $14.50 strike price and earn $86 each. If I sold all 19, I would generate $1,634 in options income and $703 in capital gains.
The Option Wheel vs. CDs. So why compare the Options Wheel to certificates of deposit? Don’t they serve two different missions in our overall financial portfolio?
CDs can serve in your emergency fund or in a captured cash flow account between saving and investing. However, we can’t let our money sit still forever.
The key is that the Options Wheel is an aggressive trading strategy that works in any interest rate environment. This scenario only works because CDs are paying 5.5% interest today.
Fitness in the Metaverse
What happens when interest rates go back to 2%? Can you let your $100,000 CD generate $2,000 per year?
At some point, we must evaluate all risk factors and step out into the void. Having $100,000 safely in a CD sounds good, but “savers are losers.”
Robert Kiyosaki hurt many feelings when he said, “Savers are losers.” If you cannot turn your $100,000 into $200,000, then you will lose.
We cannot wait for the bank to pay us enough interest to double our money, it would take far too long. We must understand the rule of 72.
The rule of 72. To find out how long it would take to double our money, we take 72 and divide it by the yield. Therefore, with a 5.5% yield, it would take 13 years to double; at a 2% yield, it would take 36 years.
Budget vs. Fixed Income
Let’s look at our Options Wheel portfolio. We had $60,000 earning 5.5%, and $40,000 earning 30%. Overall, we created ($3,300 + $12,000) $15,300 in cash flow against $100,0000 for an interest rate of 15.3%.
Using the rule of 72, we would double our money in 4.7 years. Not bad, especially since over half of our money was safely tucked into a money market fund.
Conclusion. There is nothing wrong with holding our money in a certificate of deposit. They are fast, safe, and simple, but there is no risk; no risk equals no reward.
My main objection to investing in CDs is that it prevents our brains from thinking of ways to earn more yield. In a high-interest-rate environment, everyone thinks they are smart because they earn a 5.5% yield on a CD.
Friendships in the Metaverse
However, in 2020, yields were around 1% or less. There is nothing sexy about those yields or having $100,000 earn you $1,000 annually.
However, during those times, people using the Options Wheel were still earning 15-30% yields on their investments. They never slowed down because they learned to make money in all types of financial environments.
The Options Wheel (covered calls + cash-secured puts) is simple but has some nuances. You’ll need to play around with your strategy to find the timing and volatility scenarios that fit your temperament.
Stock Market Down? Dividend Yield Up!
However, very few people on this Earth can generate a return on a pot of money. Even if you set your goal to earn $50 per month from the Option Wheel, that knowledge would set you free.
Life is about taking risks. However, we can use all the financial tools at our disposal to protect our wealth and mitigate our risk profile. If we have $100,000, maybe we play with $5,000 in the Options Wheel—that’s a way to reduce risk.
Ultimately, those who take risks will set themselves up for financial freedom. If you had $2 million in a CD at 5.5%, you would generate $110,000 in annual interest income, which would allow you to retire.
However, if interest rates went to 1.5%, you would now earn $30,000, and you could do nothing about it. That’s why it is vital we learn how to generate our own returns. Good Luck!
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