The 4 Questions of Renting Shares

Here re the four questions we always are asked when teaching the Renting Shares (aka Covered Call) strategy.

Question 1: Why would anyone pay me to buy my shares at a higher price than I paid for them, or a higher price than they’re currently trading?

Answer: People enter into agreements to buy shares at a future date like this all the time. Why? Because the person who pays us for the right to buy our shares believes that the price of the shares is going to increase sharply before the end of the month.

So let’s see what happens. Let’s say the stock price rises to $31.50 by the end of next month.

If this happens then the person who rented our shares would be able to buy them for $30.00 (the price we agreed to sell at) and sell them for $31.50 (the trading price at the end of the month), making a $1.50 profit.

If we subtract the 90 cents they paid us, then that’s a net profit of 60 cents. They only put up 90 cents per share (the rent they paid us) so if the shares do go up to $31.50 then they have made a 66% return on their money in a little more than a month i.e. 60 cents profit on 90 cents down = 66% return.
Now look at what’s happened to us in this renting shares agreement.

We bought the shares at $28.00, rented them out at $29.00 and received 90 cents rent.

If the shares don’t reach $29.00 by the end of the month, then we get to keep the $900 rent paid plus we keep our shares. How good is that, $900 out of thin air.

If the stock price goes up, let’s say it rises all the way to $31.00, we’ll have to sell our shares for $29.00. For us this is another $2.00 profit or $2000 for 1000 shares i.e. we bought the shares at @28 and sold them at $30. This makes our total profit $2900 for the month i.e. $900 rent plus $2000 profit on the sale of our shares, making a $1.00 profit. PLUS you get to keep the fee paid (you keep this fee regardless of what happens). So you will have made a total profit of $1.50. That’s a 7.5% profit for you in a little over a month.

So you can see that in this agreement both parties win. The difference is that the person paying the fee for the right to buy your shares is taking a bet that the stock price will rise. You on the other hand are happy to take their money, just like a lottery company takes money from people, because you know that no matter what happens you win. And do you know what you do the following month with this stock investing strategy? Yep that’s right, you do the same thing again.

Now be aware that if your stock rises to say $30.00 you’ll need to sell your stock for the pre-agreed price of $21.00.

But what generally happens when stock rise sharply like this? That’s right they tend to fall again. So you can miss out on some upside but in return you are getting cash flow. Note: You can use Paper-Trader to practice this strategy. See what returns you’d get, how the stocks behave and get all the experience you need, without risking a cent. Let’s keep going…

Answer to question 2…The good news about this stock investing strategy is that finding someone to enter into an agreement with you is actually done for you. There is a whole market of people out there, on the stock exchange, who have already placed requests to enter these agreements. You really don’t have to do anything; the stock exchange will match you as a seller with a buyer, and it happens virtually instantaneously. In reality there are thousands of people using this stock investing strategy right now; it’s been going on for years but unfortunately most average people don’t know about it.

I’ll show you later where to go to actually see on the internet what the current sellers and buyers are doing with this renting shares strategy, what stocks are being used, how much is the fee etc.

Answer to question 3…Well once again you don’t have to do much here because the sell price, the agreed date and the fee are all pre-determined for you with this stock investing strategy. You just need to go through the list (I’ll show you where to find this in a minute) and choose the one you like. Then you call your broker and say which one you want and they’ll execute the agreement. Your fee (the money the other party pays you for the right to buy your shares) gets paid into your account virtually immediately. And as we said before you get to keep this fee regardless.

Are you beginning to see the simplicity of this stock investing strategy? And are you beginning to see how effective this stock investing strategy can be at making you extra monthly cash? Depending on how many shares you currently own or how much cash you have you could easily be making an extra $3,000 per month. Well let’s complete the picture…

Answer to question 4…What’s the downside is a very obvious question, especially when it seems on the surface that this stock investing strategy so straight forward and so stacked in our favour. Well there are a couple of things to consider. Firstly, since you own the stock there is always the chance that the stock price will fall. If this happens you of course get to keep the fee paid to you but you have a paper loss on the stock.

Now in reality if you are happy to own a stock then you’ll always have the risk the stock will fall in price. Remember though that we are dealing with good stocks and history will show that stock prices on average will rise in price over time; albeit with price dips along the way.

In fact have you noticed what happens each time you receive your fee from this stock investing strategy. You actually reduce the cost of your shares so that employing this stock investing strategy continually REDUCES YOUR RISK compared to simply buying and holding the shares.

In our example, our stock would actually have to fall to $19.50 before we lost any money. That’s $20.00, the price we paid for the stock, less 50 cents the first fee we received. So it’s a risk reducing stock investing strategy.
The second thing to consider is that if the stock price does rise substantially, and it might on some occasions, our profit is limited to our agreed price. In our example our profit on the stock is limited to $1.00. That’s $21.00 the price we have agreed to sell at, less $20.00 the price we bought the shares for. However as we have already said it is much better to be the one that receives the small regular cash each month than to be the one HOPING for a big rise in price. In other words better to be the seller of hope that being the one hoping.

So how good is this stock investing strategy? It’s risk reducing, it pays regular monthly cash at around 20% to 40%+ per annum plus we’ll get some capital growth when we sell our shares. Remember too that it’s a passive cash flow stock investing strategy because we don’t need the stock price to move at all for us to receive our money.

In fact take a look at the possible scenarios… Notice what needs to happen for us to make money.

1. The stock price could stay the same at $20.00 and we make 50 cents (the fee paid to us).

2. The stock price could go up to $21.00 and we make 50 cents from the fee plus we have growth of $1.00 in our stock price. We would keep the stock because there’s no benefit in the other party buying stock from us at $21.00 when they can simply buy it from the open market at the same price.

3. The stock price could go up to $22.00 and we make 50 cents from the fee plus $1.00 from selling our shares.

4. The stock price could go down to $19.50 and we make 50 cents from the fee but lose 50 cents on the stock price (net zero loss). Yes even though the stock price has fallen by 50 cents we still have not lost anything because we got 50 cents income from the premium. This is why this stock investing strategy is less risky than buying and holding shares.

5. The stock price could fall to $19.00 and we make 50 cents from the fee but lose $1 in stock value (net 50 cent loss). If we had not used this stock investing strategy our loss would have been $1.00 i.e. $20.00 we paid for the stock that’s now worth $19.00.

So out of the five possibilities with this stock investing strategy, three result in a profit, one results in us breaking even and only one result in a loss (a paper loss at that). Even if scenario 5 did happen we would simply wait for the stock to rise back to $20.00 and do this strategy again.

Remember we only deal in good stock so history would show that these stocks track up consistently over time.