How to Rent Out Stocks Without Owning One?

In my earlier post, I covered the technique of renting out stocks which you owned through Covered Call. This is very similar to buying and owning a house outright, and then renting it out on a monthly basis. Covered call, however, requires the investor to have a sizeable capital to own the initial stock to be rented. In our previous example, that would mean forking out $2,662 for 100 unit of MSFT. Can we do better than this? Sure!

Now, let's take another analogy from real estate. Suppose we are interested in taking a rental of a whole unit with a 2-year contract and then renting it out on a monthly basis at a higher price. We will make money off the difference between the price we paid for the rental and the price we rented it out for. And above all, the initial capital used is much lower than if we were to buy the house outright. But, can this be done with the stocks market? Certainly, it can!

In the options world, this technique is termed as Bull Call Spread. I have illustrated three posts in my blog with regard to this strategy:

1. Rambling about Bull Call Spread on ROK
2. Reality of ROK Bull Call Spread
3. SLV Bull Call Spread

Let's make another illustration in continuation of our MSFT example. On 1st Dec 2012, the following are the raw prices for MSFT:

• Price of the underlying stock is at $26.62.
• Price of the long-dated call option (often called LEAPS - Long Term Equity AnticiPation Security) : MSFT Jan15 18 Call is at $9
• Price of the near-dated call option : MSFT Jan13 27 Call is at of $0.64

Unlike covered call, where we purchase the underlying stock before renting out the near-dated call option, the Bull Call Spread strategy replaces the underlying stock ownership by the LEAPS. Thus, we will fork out $900 (instead of $2,660) to buy 100 unit of MSFT which expires on the 3rd Friday of January 2015. This gives us a safety net of 3 years to recover if our decision on MSFT is wrong. Meanwhile, we will again sell the near-dated option to earn us a premium of $64.

Now, let us calculate our return of investment. On 19th Jan 2013, if the price of MSFT is above 27, we will surrender 100 units of MSFT. When this happens, we will pocket $2,700 but will have a short position of -100 units of MSFT because we did not own the stock in the first place. In order to stay in neutral position, we will need to exercise our LEAP call option. For this, we will pay the balance of $1,800. So, in nett, we will earn $2,700 + $64 - $900 - $1800 = $64.(7.11% for 48 days or 54% per annum). 

If the price remains below $27 on the expiry date, we can start another round of selling near-dated call options and earning the premium again. We can repeat this again and again until (a) the price goes beyond our near-dated strike price ($27) or (b) we reaches the 3rd Friday of Jan 2015. Suppose that on average, we can sell near dated options for around 4.5% for 30 days. This is equivalent to approximately 54% per annum. Multiply that by 3 years. I will leave this calculation of passive income to be your homework.

Bull Call Spread makes use of leverage. Take note, however, that leverage is a double-edged sword. It helps boost your gains and also worsens your losses.

On a parting note, I urge all my readers to read widely into investment materials to increase your investment knowledge. If you are unsure where to begin, you may take on a few more my recommended books.

Here are the affiliate links to some of the materials I read from:

Higher savings rate with Poems MMF (Update)

[Disclaimer: The author does not achieve any monetary gains from posting this entry.]

For those who doesn't know what POEMS is, it is a trading account. MMF is a facility to temporarily park money during stock trading. When money is put into POEMS account, it will be automatically bought into MMF at the price stated on that day. When stock trade is done, the MMF unit will be sold at the price stated on that day to pay for the trade.

Below is the data I have gathered from POEMS.

Date	Price	%price change/year[aka % interest rate]
28/12/2007	1.1054	3.30
31/12/2008	1.1205	1.30
24/12/2009	1.1319	0.81
21/12/2010	1.1398	0.77
29/05/2011	1.1426	0.58
05/01/2012	1.1461	0.51
22/03/2012	1.1475	0.58
29/06/2012	1.1494	0.61
31/07/2012	1.15	0.60
12/08/2012	1.1502	0.53
23/08/2012	1.1504	0.58
23/09/2012	1.151	0.61
21/11/2012	1.1521	0.59
06/12/2012	1.1523	0.42

If the calculation is based on the first date and the last date, the interest rate is slightly lower.

Date	Price	interest rate (%pa)
02/05/2007	1.0908
06/12/2012	1.1523	1.01

[Note: Hopefully my calculation is correct]

I am fully aware that there are many other "rainy day savings haven"; Well, I suppose I prefer POEMS MMF to others because I can gain better access to the money.

How To Create Passive Income Through Stocks Rental

Stocks, which have been bought/owned, can be rented out much like how a real estate property can be rented out. This can be done through the Options Trading, named Covered Call.


What is a Call Option?
A call option is a contract which gives the call buyer the right to buy (or call) the stock from you at a certain Strike Price. This is a right but not an obligation and it can be effected any time before the call expiry date.
An example of Call Option with the underlying stocks of Microsoft (MSFT) is MSFT Jan13 27 Call. This is a Call Option on Microsoft Stock which expires on the 3rd Friday of January 2013 with the strike price of $27.


How to use Call Option?
The first step to perform a call option is to have ownership of the underlying stock. So, we need to start with buying the stock. The lot size of option is 100 units. In order to sell 1 unit of MSFT option, we would need to own 100 unit of MSFT stock. With the earlier example, we would need to invest in 100 unit of MSFT. Considering the price of MSFT on 1st Dec '12 ($26.62), we need to fork up $2,662.

The next step is to rent out the  stock. Suppose we want to rent out our ownership of the MSFT share until the 3rd Friday of Jan (Jan 18th, 2013) with the strike price of $27. Checking out option chain for MSFT, we will obtain this: MSFT Jan13 27 Call with the price of $0.64. We start the covered call trade by Selling To Open MSFT Jan13 27 Call for $0.64. For this trade, we will earn $64.



What happens on 19th Jan 2013?
On the Saturday right after the options expiry date, two things could happen depending on the price of the underlying stock.

1. If MSFT falls below $27, the call option will expire worthless.We would not need to do anything for the previous call option and keep the $64. We can start to initiate another call option and earn another round of passive income.
2. If MSFT is at or above $27, the call option might be exercised. When this happens, we will have to let go of the share at $27. Our gain would be $27 + $0.64 - $26.62 = $1.02. This is equivalent to a return of 3.83% (48 days) or a normalized return of 29.1% per annum.

I know you have a counter-argument that we will have paper loss if the underlying stock is below the strike price (Case #1). This will happen irregardless if we trade the call option. So, why not earn some return to cover potential paper loss on the downside? And still have a great upside return?
Another point to note is that our maximum upside is limited to our strike price. The strike price should be our target selling price. This is something we should be disciplined with anyway. Buy low and sell high at our target strike price.
If you would like to learn more about options trading, I would recommend reading the following books:

1. Getting Started in Options
2. Show Me the Money: Covered Calls & Naked Puts for a Monthly Cash Income
3. Exit Strategies for Covered Call Writing: Making the most money when selling stock options

Please do leave some comments if you like the post.

SLV Bull Call Spread

Yet another real example on Silver (SLV).

Date	Type	Qty	Ticker	Cost basis	Amount
12/28/2011	Buy To Open	6	SLV Jan14 15 Call	$14.11	($8,475.12)
12/28/2011	Sell To Open	6	SLV Mar12 30 Call	$1.11	$656.86
1/10/2012	Sell To Close	6	SLV Jan14 15 Call	$15.38	$9,218.69
1/10/2012	Buy To Open	6	SLV Mar13 15 Call	$14.85	($8,919.13)
1/17/2012	Buy To Close	6	SLV Mar12 30 Call	$1.60	($969.13)
1/17/2012	Sell To Open	6	SLV Apr12 30 Call	$2.10	$1,250.84
4/2/2012	Buy To Close	6	SLV Apr12 30 Call	$2.37	($1,431.13)
4/2/2012	Sell To Close	6	SLV Mar13 15 Call	$17.37	$10,412.63
				Total:	$1,744.51
				Gain(%):	20.58%
				Gain Per Annum (%):	61.75%

Reality of ROK Bull Call Spread

Let's put the previous post into a reality check.

Date	Type	Qty	Ticker	Cost basis	Amount
9/19/2011	Buy To Open	1	ROK Apr12 35 Call	$24.06	($2,413.50)
9/19/2011	Sell To Open	1	ROK Oct11 65 Call	$1.06	$98.50
9/27/2011	Buy To Close	1	ROK Oct11 65 Call	$0.93	($94.52)
9/27/2011	Sell To Open	1	ROK Nov11 65 Call	$1.98	$196.48
10/6/2011	Buy To Close	1	ROK Nov11 65 Call	$2.39	($240.89)
10/6/2011	Sell To Open	1	ROK Jan12 65 Call	$4.49	$447.10
11/17/2011	Buy To Close	1	ROK Jan12 65 Call	$9.96	($997.52)
11/17/2011	Sell To Open	1	ROK Apr12 70 Call	$9.46	$944.46
4/20/2012	Sell To Close	1	ROK Apr12 35 Call	$0	$0.00
4/20/2012	Buy To Cover	100	ROK - Option Exercise	$35	$3,500.00
				Profit:	$1,440.11

This would be $1440.11 profit from the initial investment of $2413.50, which is a gain of 59.67% over a period of 7 months, which is 102.29% pa. This has already taken into consideration the trade commission and registration fees.

So, is Call Bull Spread the best strategy? I would say I had a good entry point and the market were on my side.
Make your own CALL, though.