Stocks

Rental Income from Stocks? Here’s the Scoop…

By Lee Lowell  |  November 16, 2018

I hope those shares of stock sitting in your account are doing more than just sitting.

Sure, they may have gone up in price, giving you capital appreciation. Or, they may not have.

Regardless of whether your stocks have made money for you or not, there is a way to squeeze some extra income out of them.

Did you know you can “rent” out your stocks and receive a steady income throughout the year?

Here’s how you do it (and why you should)…

The Rent Helps Cushion the Fall

As we currently undergo a very nasty pull-back in the market, I’m sure you’ve wondered and wished there was a way to help buffer the bloodletting to your portfolio.

Well, if you have at least 100 shares of any stock, there is a simple strategy to help cushion the fall.

Selling covered call options.

That’s the ticket!

When you sell a call option to someone (call option buyer), they pay you an upfront fee in exchange for potentially buying your shares from you at a later date.

How much is the upfront payment and what price will they buy the stock from you?

That depends…

There are lots of different scenarios to choose from, some of which depend on the stock itself, its current price, and the option expiration date. The good thing is that you can control much of the process.

Let’s look at an example.

Walt Disney (NYSE: DIS) is a stellar stock and has gone up five-fold in the last 10 years.

It currently sits near $117 per share after bumping up against all-time highs near $120 just last week.

Around this time in 2008, it was trading near $20 per share. That’s been a nice $100 gain for anyone who stepped up and bought.

Check out the monthly chart below:

Let’s say you were smart enough to buy 100 shares at $35 a piece back in 2008. You didn’t nail the bottom, but you were able to grab a huge chunk of the gains.

You’re now sitting on an $82 per share gain, netting a paper profit of 234%.

But with the recent pullback in the market and Disney hitting upon chart resistance at $120 per share, you want to protect yourself a bit without selling all your Disney stock.

Let’s see how selling covered calls can help…

How Much Rent Can You Get?

Looking at the Disney option chain below, which shows a sampling of call options for the April 2019 expiration, we can figure out the best course of action.

The keys to selling call options successfully is a two-step process:

1. You want to choose an area above the current stock price.
2. You want to choose an expiration period and premium that makes it worthwhile. And still gives some downside protection.

In regards to item #1: since DIS is an exceptional stock, you’d like to continue to hold for as long as possible, as more price appreciation can occur. This is why it’s imperative to pick a strike price that’s above the current stock price.

But why?

Because if the stock ends up above the strike price at expiration, you’ll be obligated to sell your shares to the buyer at the stated strike price. So, if you have to sell, make sure it’s at a price where you’d be happy to let them go.

If the stock doesn’t end up above the strike price at expiration, the call option will expire worthless, your obligation to sell will go away, and you can now sell another call option to repeat the process.

And you keep the cash you pocketed at the outset!

Let’s key in on the April $130 call options in the graphic above.

For every 100 shares of stock you own, you can sell one call option contract.

The $130 calls have a fair value of $2.24 per contract (splitting the bid/ask).

By selling it, you’ll get $224 ($2.24 x $100 option multiplier) upfront and in your pocket.

In exchange for the $224, you’re now “renting” out your shares to the call option buyer until April 2019 expiration.

If DIS shoots above $130 by that date, you will relinquish your shares and lock in your final gain of $95 per share, plus the upfront payment of $224.

If DIS doesn’t move above $130 by April, your shares are released back to you and you can sell another call option while keeping that $224.

Why did I choose April 2019 and the $130 strike?

Well, $130 is $13 above its current price of $117, and well above the $120 resistance level, making it an area that would be hard to breach. You’re also allowing for normal ebb and flow.

I chose April 2019 because it pays a good upfront premium, which can also act as a buffer during stock pull-backs.

The longer the expiration, the larger the premium you get. This is helpful if you feel a larger pull-back is in the offing. But at the same time, you’ll be renting your stock out for longer, allowing more of a chance that it can move above the strike price.

The reason why this strategy is named “covered calls” is because the 100 shares you own will cover the outright sale of the call option contract.

Anyone selling the call option by itself is engaging in “naked selling,” which is extremely risky because it has an unlimited upside loss potential. We don’t want that!

So go ahead and put your long shares to work. Rent them out for a fair price, and make sure that, if you must sell them, you’d be OK with letting them go at the agreed upon level.

The more you know…

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Lee Lowell

A former Wall Street insider and floor trader, Lee Lowell has worked in the market for nearly 30 years now. He began his option trading career in 1991on the floor of the New York Mercantile Exchange (NYMEX) in New York City.MORE FROM AUTHOR