Options Strategies for Irrevocable Trusts: Enhancing Trust Growth Through Strategic Premium Collection
By Steven J. Oshins, Esq., AEP (Distinguished)
Irrevocable trusts serve as the cornerstone of multi-generational estate planning, offering asset protection and estate tax avoidance. However, traditional conservative trust investment strategies, often heavily weighted toward buy-and-hold equities or fixed income, can struggle to outpace taxes, administrative costs, distributions, and inflation over extended horizons.
For fiduciaries and financial advisors, options strategies, specifically selling short puts, present a sophisticated, tax-efficient mechanism to harvest equity risk premiums and generate consistent cash flow. When executed within strict risk parameters, option selling can systematically lower the cost basis of trust-acquired equities while accelerating long-term asset growth.
What is an Option?
An option is a financial derivative representing a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price (the strike price) on or before a specified date (the expiration date).
Calls vs. Puts
- Call Option: Grants the holder (buyer) the right to buy 100 shares of the underlying asset at the strike price. The writer (seller) is obligated to sell the asset if assigned.
- Put Option: Grants the holder (buyer) the right to sell 100 shares of the underlying asset at the strike price. The writer (seller) is obligated to buy the asset if assigned.
Why Option Selling Outperforms Option Buying
A foundational mistake made by many investors is treating options as leverage instruments for directional speculation (buying calls or puts). For trustees managing irrevocable trusts, option writing (selling) offers advantages because the option seller usually wins more than the option buyer because of volatility decay.
Every option contract consists of intrinsic value (in-the-money amount) and extrinsic/time value. As an option approaches expiration, its time value decays exponentially. Option buyers face a constant, accelerating drag from time decay. Option sellers profit from time decay every day the underlying asset stays above (for puts) or below (for calls) the strike price.
When a trust buys an option that is far out-of-the-money, it requires a significant directional move in a short timeframe just to overcome time decay and break even. Conversely, when a trust sells an option that is far out-of-the-money, it can profit under three distinct outcomes:
1. The asset moves in the favored direction.
2. The asset moves sideways.
3. The asset moves against the trade slightly, provided it stays beyond the strike price at expiration.
If call and put option skew were the same, call and put options with equivalent distances out-of-the-money would trade at identical implied volatilities. However, because of the so-called volatility skew, out-of-the-money put options command significantly higher premiums than out-of-the-money call options that are the same distance away.
Core Options Strategies
When implementing option selling within an irrevocable trust, advisors generally choose between naked puts, covered calls and defined-risk spreads.
1. Naked / Cash-Secured Puts: A naked put involves selling an out-of-the-money put option while maintaining sufficient liquid cash or high-quality cash equivalents in the trust account to purchase 100 shares of stock at the strike price if assigned.
2. Credit Spreads (Vertical Spreads): A put credit spread involves selling a short put at a higher strike price while simultaneously buying a long put at a lower strike price for the same expiration date.
How Much Leverage is Enough?
Selling naked puts generally results in a lot of consistent easy money. While things are working well, there’s a tendency to increase the amount of dollars at risk in order to make even more “easy” money.
However, the primary risk in selling naked/cash-secured puts is not stock assignment. It is over-leveraging during periods of low volatility, followed by a significant volatility expansion.
During bull markets, the CBOE Volatility Index (VIX) tends to drop, resulting in smaller options premiums. Tempted by low yield, inexperienced managers may sell excessive numbers of options contracts to meet income goals. When market shocks occur (e.g., VIX spikes from 13 to 35+), options prices explode exponentially.
For those who have never sold naked puts and lived through a period where you had a basket of naked puts at a time when there was a major crisis, you can’t imagine how quickly and violently puts (and calls) can expand in value because of the increase in volatility.
Two extreme examples come to mind. My personal trust brokerage accounts got crushed during the 2008 real estate crisis and the 2020 COVID crisis. I survived both, but it took time to make the lost money back. Fortunately, I’ve made a lot more than I’ve lost, and have been doing so for many years, so I look at it as “the cost of doing business”. But as a veteran options trader, my best advice for new traders is to keep your naked puts very small until you’ve traded through at least one extreme VIX expansion so you have a better understanding of risk management.
ABOUT THE AUTHOR
Steven J. Oshins, AEP (Distinguished) is a member of the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011. He was named one of the 24 “Elite Estate Planning Attorneys” and the “Top Estate Planning Attorney of 2018” by The Wealth Advisor and one of the Top 100 Attorneys in Worth. He is listed in The Best Lawyers in America® which also named him Las Vegas Trusts and Estates/Tax Law Lawyer of the Year in 2012, 2015, 2016, 2018, 2020, 2022, 2024 and 2026. He can be reached at 702-341-6000, ext. 2 or [email protected]. His law firm’s website is www.oshins.com