Going back more than 50 years, a chart of the S&P 500 shows a generally upward movement, marred by a few setbacks, until it finally peaks at 1,527 in March of 2000. Since then, the index has plummeted to around 770 in 2002, moved to a slightly higher peak in 2007, fallen back to around 675 in early 2009 and climbed to about 1,100, as of this writing. Thus, the broader U.S. stock market appears to be somewhere right in the middle of a decade-long trading range.

If the market continues to move sideways, a classic investment strategy may make sense-selling covered calls. These transactions offer appreciation potential, but they also provide income in these low-yield times and offer a partial cushion to falling stock prices.

With some effort, financial planners can help clients use covered calls and related strategies. Advisors who would rather spend their time elsewhere can choose among several funds designed to execute these option plays.

"Some financial advisors automatically associate options with more risk," admits Thomas J. Schwab, chief investment officer of The Collar Fund. "However, they may not know that options can also be used to reduce investment risk."

COVERING UP

With a covered call strategy, an investor sells ("writes") an option to buy a stock he or she owns, and then collects the sales premium. Typically, the option will be "at-the-money" (the exercise, or strike, price is the same as the trading price) or slightly "out-of-the-money" (the strike price is a bit higher than the trading price). Such buy options, known as calls, may be in effect for only a few weeks or for many months at a time.

"Increasingly, investors and clients are thinking in terms of income and not solely appreciation," says Ron Altman, portfolio manager of Aston/M.D. Sass Enhanced Equity Fund. "Covered calls can add to the income stream."

Increased income may appeal to both planners and clients. "I have a client who sometimes inherits shares of Coca-Cola," recounts Sheila Chesney, a financial planner in Sheldon, S.C. "We may sell covered calls on those shares to get some extra income before we sell the stock."

Recently, Coke shares were trading around $55. If that client were holding any shares, Chesney says, she might have sold at-the-money ($55 strike price) options expiring in six months.

At this writing, those options were quoted at $2.20. That is, an option buyer would have paid $220 for the right to buy 100 shares of Coke at $55 per share. If Coke shares moved higher than $55 over the next six months, that buyer could have exercised the option and paid $5,500 for 100 shares. If Coke shares never topped $55, the option would then expire, unexercised, and Chesney's client would have been able to write another call.

Either way, Chesney's client would have received $220 from a $5,500 position-a 4% return on her investment. Assuming the option was in place for the full six months, that would have been an 8% annualized return, in addition to any Coke dividends that Chesney's client received while still holding the shares.

VIX FOR VOLATILITY

Nadia Papagiannis, alternative investments strategist at Morningstar, believes such covered call strategies may make sense in today's uncertain market environment. "Investors may be able to take advantage of volatility and potentially receive a better risk-adjusted return, compared with a long-only equities portfolio," she explains. "You do need some expertise, though. It's not easy to tell whether the premium you receive for selling the call is worth the cap you place on the stock's upside."

Although volatility is often nerve-wracking for investors, it may be good news for options sellers. In volatile times, stocks can move up and down quite rapidly. Options buyers might be willing to pay more for a call if there's a good chance the stock's trading price will move higher than the current trading price some time during the option's life.

"Advisors can just follow the VIX," says Jon Najarian, co-founder of tradeMonster, an online brokerage firm, referring to the ticker symbol for the Chicago Board Options Exchange Volatility Index. "The higher the VIX goes, the more volatility in the stock market, which generally means higher prices for selling call options. By looking up the 12-month high-low on the VIX, you can tell whether or not it's time to be aggressive in selling calls for your clients," he explains.

Najarian says the VIX has moved between 16 and 36 in the last 12 months. "At 32, I was aggressive about selling calls," he says. That is, high volatility pushed up the price of calls, so Najarian was willing to sell a call that would stay in effect for a month or two, thus earning a substantial premium.