By hedging with short SH and short TBF you should get an annualized return in your desired (5) - 10% range.
The spread between a riskless asset and a positive return of anything greater than 5-7% is near or exceeds historical expectations for equity risk premium, so in essence, yes, you are trying to beat the S&P. And no, prudent overwriting adds no more risk than already exists with the individual underlying, at least with a broad-based index. Take a look at the CBOE's relatively pedestrian PUT and BXM index experiments. And you can do better than these with only a modest amount of effort. But it's not a completely passive venture. You'll have to put in some effort. But of course, your capital preservation requirement will have to be relaxed. Without more info, it's not clear why you need such a strict requirement. Why you could even overwrite an entire MPT basket. I'm not sure why you want to avoid bonds if your required return is relatively modest. A portfolio of bonds could come very close to your initial desired requirement of 1-5% over CD rates. For instance, if capital is a non-limiting factor, the safest position is to own a diverse portfolio of bonds of suitable risk criteria and generate your minimum income in that fashion. The greater your capital, the less risk you should take. Capital preservation requires avoidance of volatile assets.
What are people's thoughts on "Target-Date Funds" as a way of achieving a risk-averse portfolio for income?