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:

Vehicles of Investment.

Dear Readers,

How many forms of investment vehicles are you exposed to? How many of these are you employing in your financial plan?

I have gotten a fair bit of exposure to different kinds:

1. Savings
• I bet almost all my readers do have a savings account. This is by right the best capital protected form of investment available. Capital protection does not mean safe, though. Main reason because the interest paid is normally meager compared to the rate of inflation. Thus, your money decays away as the cost of goods increases.
• These days, there are more and more financial banks offering competitive enhanced savings account with higher interest rates. To name a few are POSB My Savings, OCBC Monthly Savers, Standard Chartered XtraSavers, Citibank Step Up Account and a few others.
• However, this form of investment is mainly for my daily uses substitute of cash. Not for interest sake
2. Fixed Deposit
• This vehicle is normally offered by banks. The interest rate is slightly higher than Savings but your money is locked in for a couple of months or years. 
• Again, Return on Investment is not significant.
3. Mutual Funds/Unit Trust
• I started on this in the year 2007 via Fundsupermart. Financial crisis year? Tough luck...
• Lesson learned from this mode of investment is that if you do not want to actively manage your money, you let others' do it. But, there is a price to pay. Those fund managers can be pretty costly.
• Why do I say so? In the financial downturn, your funds goes downwards, you suffer paper loss and at the same time still have to pay those "hardworking" fund managers who cannot do much to bring the fund to give you some gains.
• So, early 2011, I moved on... cutting loss and leaving the Unit Trust world.
4. Stocks
• Large population of Singapore residents are into this baby. I ventured into this mode of investment because Unit Trust costs money. Why let fund managers manage the funds if you can get your hands dirty with stocks investment itself?
• I started my trade with penny stocks which I have regretted to this date. It is a lesson learned not to own stocks you do not want to hold for long. Because, you will end up holding onto them with losses.
• I have ventured into US Stocks as well. There are generally more volatility in US market as compared to SG market. More gains and/or more losses.
5. Warrants
• Similar to stocks, this instruments are time-bound and are leveraged. With small amount of money, you can win big or lose big.
• However, since it is time-bound, there is time decay. As time goes by, your warrants loses time value, thus it loses money.
• With warrants, you can buy either call (similar to having a long/buy position of the underlying stock) or put (similar to having a short/sell position of the underlying stock)
6. Options
• This mode of investment is very similar to warrants. While warrants allow you to be on the buyer side for call and put, options allow you to be on the side of either the buyer or the seller side of both call and/or put.
• Options are time-bound and are leveraged, too
• However, I learned many strategies with options which can put you into gambler hat or conservative Scrooge McDuck (Donald Duck's uncle)
• Let's talk a little on the conservative side:
• Capital secured Put: With this, you place money into the brokerage house in view to buy a stocks at a certain strike price with a certain expiry date. You Sell To Open a put option and get paid some premium (^$-$^) . If the stocks goes higher than your strike price at expiry date, you get to keep the premium and nothing happened. If the stocks goes lower than the strike price, you get assigned the stocks. Note: Do NOT place this bet on stocks you do not wish to own.
• Covered Call: If you own some stocks which has options chain (or assigned a stock because of the Capital Secured Put strategy), you can "rent out" these stocks using covered call. Here, you Sell To Open a call option on the stocks you own with a certain strike price (choose strike price higher than your cost basis/average price, or you will end up losing money on the trade). With this trade, you will also get paid some premium (^$-$^)
• I shall update some other strategy which can be done with options.
7. There are many more investment vehicles which I have yet to get my hands into (not in order of importance)
• Forex
• Treasury Bill and Govt Bonds
• Land Investment
• Wine Investment
• Antiques
• Property investment

Let's hope that as time goes by, these vehicles can provide me with smoother rides into the RICHER destination

~ Erwin Liong ~