The principles of renting shares are similar to renting out your house. When we rent out our house, the tenant pays us rent, every month, for the use of our house. When we rent out our shares we receive a premium (another word for rent) and for this we give the other party the use of our shares.
For example, say we own 2000 shares in Microsoft that we bought for $28 per share. We might decide to rent them out for a month and when we do this we receive say $0.80 per share i.e. $1,600 (2000 shares x $800 = $1,600). Don’t worry about how this happens for now – just focus on the strategy.
The $1,600 is deposited to our trading account that same day and it’s ours to keep – we never have to give it back (same a renting out our house). So we’ve just received $1,600 for a month’s rent of our Microsoft shares.
If done correctly, the renting shares strategy is one of the safest around but one that can deliver a whopping 20% per annum. And it’s a strategy that you’re able to do it in your IRA or Superannuation account. It’s a perfect cash flow strategy because we receive money in to our account the day we do it – and we don’t need to be in front of the computer all day.
Now the difference between ‘renting our shares’ and ‘renting our house’, is what we’re actually providing to the tenant – in the case of ‘renting our house’, we’re giving them the right to occupy our house in return for rent.
Whereas in the case of ‘renting our shares’, we’re giving them the right to buy our shares at a pre-agreed price (the rental price), in return for rent,or premium as it’s called.
For example, we might decide to rent our $28 Microsoft shares at a rental price of say $28.50 for a month, and for this we’d receive 0.80 per share ($1,600 in total for our 2000 shares).
Again, don’t worry the mechanics of agreeing on the rental price, or the rental premium or even finding someone to rent your shares – this is all done for us by the stock exchange.
I’ll explain more about this later.
So things are still pretty straight-forward, right? We rent our shares, and we receive cash for doing this, the rental premium.
When we rent our shares we are giving the tenant the right to purchase our shares at a pre-agreed price (the rental price). In our example we bought the shares for $28, and rented them out $28.50.
And for this we receive $1,600. Now here’s the key question… why do you think someone is willing to pay us $1,600 to rent our share at $28.50 (a full 50 cents more than they’re currently trading)?
The answer is this… the people who rent our shares are Traders. They sit in front of their computer all day buying and selling. When a Trader rents our shares from us they are betting on the stock price rising.
If it does, they can make a handsome quick profit by selling the rental contract to someone else. Billions and billions of dollars is traded daily –it’s a huge market.
In the case of our Microsoft shares that we rented at $28.50, the person who rented our shares paid us $0.80 per share. If they are right and the stock price does rise, from $28 (the current price) to say $28.25 in 3 days, the $28.50 rental agreement that they paid us $0.80 for, might be worth $1.00.
That’s a $0.20 profit for the Trader in 3 days, or in other words, 25% return in 3 days. But if the stock price falls instead, then the agreement that the Trader paid $0.80 for might fall to say $0.60 in 3 days, that’s a 25% loss in 3 days.
So it’s true that you can make a lot of money fast being a Trader, but it’s equally true that you can lose a lot.
For us though, we’re on the side of the smart money. The reason this renting shares strategy is so powerful, is because we have a defined, predictable amount of cash coming in i.e. the rental income.
And instead of sitting in front of the computer and worrying about what the stock price is doing, we can go to the beach.