Millions of aging baby boomers and bond yields at a paltry 6%. They're like two freight trains on a collision course.

The search for income need not be a wreck. But alternatives to traditional sources of income have some hurdles to clear. Ideally you'd like the income to be higher than the yield on good quality bonds and have some reasonable protection of principal.

INVESTOR'S CORNER

That's a challenge to be sure, but possible for investors who are willing to use options within the context of an income portfolio. The strategy of choice is covered-call writing, which means you would sell options on stocks you own.

Covered-call writing is quantitatively riskier than a bond portfolio. However, when you move beyond quantitative analysis, average investors measure risk in terms of their comfort level. Comfort comes from an understanding of the strategy and the long-term outlook for the underlying stock.

Income And Risk Levels

To build an acceptable income portfolio, you must first decide what level of income you want. Then ask yourself whether you're willing to spend some of your principal to get it.

Right now you can earn about 5.6% by purchasing a U.S. government bond portfolio with a maximum maturity of about 10 years. On a $100,000 portfolio, you earn $5,600 per year and your principal is protected. If that income satisfies your needs, then look no further.

For many, 5.6% is simply not enough. Your choices? Either dip into your principal to get your desired income or assume greater risk in order to get a higher rate of return. Since most investors want to retain their principal, the real solution is to find a higher-risk, higher-return alternative.

Options can provide a solution. But understand that the option premium reflects the risk -defined as volatility volatile the underlying security. The more volatile the underlying security, the higher the option premium.

That takes us to the next issue: is your principal secure at that level of income? While there's no way to guarantee your principal, long-term covered calls do provide an interesting alternative.

Selling Long - Term Intel Calls

An income portfolio really should include a number of securities with varying degrees of risk. But for our purposes we'll assume a $100,000 portfolio is used to purchase 1,400 shares of Intel at 69 per share. The total investment equals $96,600 (not including commissions), leaving the portfolio with a $3,400 cash reserve.

At the same time, you would sell 14 Intel January (2002) 70 calls for 20 per share. These calls obligate you to deliver the 1,400 shares of Intel at 70 per share to the call buyer anytime between now and January 2002.

If the stock is called away at 70, you receive ($98,000. Add back your original $3,400 cash reserve and the total portfolio value is $101,400. Take out full-service commissions and that's essentially the return of your original principal.

With this position you receive $28,000 (20 per share times 1,400 shares) in premium from the sale of the calls. You can draw on that during the next 29 months without having any impact on your initial principal, assuming Intel is above 70 at expiration.

Of course, the principal is not guaranteed as it is with a bond portfolio. So you have to ask how likely it is that Intel will be worth at least 70 per share 29 months from now. How you answer that question will define how comfortable you are with the approach.

Staying with our 8% target, you can draw $8,000 per year or $666,67 per month on your initial $100,000 principal investment. Total income over the next 29 months would be $19,333.

The best-case scenario will see the stock above 70 in January 2002. At that point, the calls will be assigned and you will deliver your 1,400 shares at 70 each and receive $98,000. You also will have the initial $3,400 cash reserve when the position was established plus the $8,667 in excess premium, which gives you $12,067. The total portfolio would be worth $110,067, which wouldn't account for any dividends received, interest earned on the excess cash or transaction costs.

The worst-case scenario would see the value of Intel shares decline below 70 at expiration. In this case, you retain the shares plus the $12,068 excess cash reserves that weren't paid out as part of your income requirements. Think of the cash reserve as a cushion against the loss of your original principal. Which leads to the final questions: At what stock price do you begin to forfeit you initial $100,000 principal?

To calculate that, subtract the $12,067 cash reserve from your initial $100,000 principal, leaving you with $87,933. For your principal to remain intact, the value of the 1,400 Intel shares must be at least $87,933 or about $62,80 per share.

As for the risk of earning 8% annually over the next 29 months: How comfortable are you with the notion that Intel will be worth at least $62.80 in January 2002?