Have you seen the teaser pitch from Amber Hestla about her little-known strategy for becoming a “stock landlord” and earning income by renting out your shares? It sounds appealing, and like the kind of thing you imagine the big investors must be doing to get an edge, right?
Well, sort of — let’s look at the tease and see exactly what it is she’s talking about. Here’s how she gets us intrigued:
“Did you know you can receive a monthly income from the stocks you own…
“…much like you would from a rental home?
“… the stocks in your brokerage account can also generate monthly income, much like a rental property. But you’re probably not taking advantage of this.
“Consider for instance, that if you owned a $150,000 apartment in Boston, Houston or Seattle… depending on the neighborhood, you’d collect about $1,400 a month in rent.
“Likewise, if you owned only $80,000 worth of stock in companies like Apple, Facebook and Intel… you could essentially do the same thing and collect $1,400 a month on them.
“The best part is, this income is in addition to the dividends these stocks already pay you.”
She compares this to the fact that big funds and ETFs routinely generate a bit of income by “renting” their shares — but that’s a bit different, those are shares that are being rented to short-term traders or short-sellers, who pay a bit of interest or a fee for the “borrow” of the stock because they want to bet on the movement of the price over a short period of time without actually buying a big position. That really is kind of like “renting”, but you generally can’t do it as an individual investor (though if you hold your stocks in a margin account, your broker is probably renting them out and keeping the fees).
What Hestla is pitching here for her Maximum Income service is options selling — and primarily, since it is sort of like “renting” out your stocks, the sale of covered call options. Hestla has been touting the basic options-selling strategies for a year or so, for both Maximum Income and Income Trader, which for some reason costs a bit more ($499 vs. $299 — these kinds of letters are generally fairly expensive, since options trading is illiquid in most names and the market can’t absorb thousands of subscribers all trying to do the same thing at once), and this may well not be brand new to you — but since folks have asked, I’ll run down exactly what covered call selling is (I’m stealing the examples from an article I wrote last Fall when she was pitching the “Hestla Heist” and I covered the put and call selling she talks about in more detail, so the numbers are probably a bit off but will still give you the general picture).
Options trading is pretty simple, if dangerously levered in some cases, but it uses a different lexicon so sometimes novice investors find it baffling. The basic idea of covered call selling is that you own a stock, and you’re willing to sell someone the right to buy that stock at a particular price for a defined period of time (typically two or three months in most strategies, though options can go out a couple years in some cases), and these “rights” are sold as standardized options contracts — not all stocks have options, but larger companies are more likely to have options trading available than smaller companies.
Here are the terms you probably need to know to understand options on the most basic level:
Strike price: The contracted price at which the stock can be bought (call option) or sold (put option), at the option buyer’s option
Exercise: The act of asserting your right on an option you bought — buying (call) or selling (put) the stock.(buyers are not obligated to exercise options, that’s why it’s called an “option”, they get to choose, sellers are obligated to exercise at the buyer’s behest because they’ve sold someone the right to make that choice — that would mean the seller has the obligation “assigned” to them)
Expiration date: The last day the option can be exercised, after this day it disappears and becomes worthless. Technically the standardized expiration dates are on Saturdays, when markets are closed, so the real expiration date is the Friday before.
Open Interest: The number of options contracts that exist for that particular combination of strike price and expiration date. Open interest drops when a contract is bought back to close it or exercised, it rises when a new contract is created by a “buy to open” or “sell to open” order.
Volume: The daily trading in a specific option contract — this number is wildly inconsistent across quote services and brokers, but you can usually tell if the contract is changing hands with any frequency if the bid and ask are relatively tight and the volume is at least in the 100s of contracts.
In the Money/At the Money/Out of the Money: Terms to describe whether an option has actual value (sometimes called “intrinsic value”) at any given time because of its relationship with the current price of the underlying stock. For a call option, if it’s an option to buy at less than the current price of the stock then it’s “in the money” because you could exercise the option and make money immediately… “At the money” would mean the option strike price is right at or very near the current stock price, “Out of the Money” means it could not be exercised at a profit at the current stock price and any value for the option is based on the uncertain future.
Time Value: This is one way people refer to the premium price of an option contract — a $15 call option with a January expiration for a stock that’s currently at $10 is all “time value” or premium because the option has no exercise or “intrinsic” value today, it’s the price the market (sometimes just you and the person taking the other end of your trade) puts on the risk or the potential (depending on which side you are) of the stock rising 50% in four months. Time value will be higher for stocks that tend to or are expected to move more or faster.
There are lots of other things that options traders follow very closely, including “Implied Volatility” (basically, what the option prices imply about how volatile the stock will be), the greeks (Gamma, Delta, etc.) and other measurements of volatility and volume and speed of price movement, but those — while useful for active traders — are not as important to understanding the basic concept.
Pretty much any investor can trade options, but you have to first get approval from your broker because they’re obligated to make sure you understand the basic idea and the risks before you get involved — with most brokers, that’s five minutes to fill out an online questionnaire and then they assign you to an approval level… generally brokers have several levels of approval, with the first step being that they will let you sell or buy options directly related to your stock holdings (sell a covered call, buy an “insurance” put) and the next step being the approval to “speculate” on buying calls or puts, then to doing more complex multi-legged options trades (spreads, straddles, strangles, butterflies, lots of odd-sounding combinations that can cap risk or bet on multiple outcomes). The highest level is reserved for those who want approval to sell uncovered or “naked” options, which is what most of the “options income” newsletters, apparently including Hestla’s, are recommending most of the time (partly because those generate more impressive-sounding numbers).
Covered calls are probably the most popular income-generating option strategy for individual investors because the risk seems a lot less scary than selling puts (even if it isn’t necessarily less risky in the big picture). Investors sell covered calls against stocks that are in their portfolio — so you might own 100 shares of Microsoft, for example, and you’re enjoying the 2.5% yield, and you think it will be a nice stock to hold for a long time… but you’d rather boost your yield to 5 or 6% or even a bit more.
You can do that with covered calls — if you have 100 shares you can sell one covered call contract, so, for example, you could sell a contract at $50 for December, thinking that if the stock jumps by 8% in a few months you’d be happy to sell at $50 anyway, and you’d get about 50 cents for selling someone else the right to buy your MSFT shares for $50 before the December expiration. If you can do that three times a year, keep rolling over for similar amounts each time the option expires, then you can earn another 3-4% a year in cash returns.
Or, of course, the stock could hit the strike price or go far higher, and you sell it at $50. Selling covered calls means you’re capping your gains in exchange for relatively small upfront cash payments (with more volatile stocks, or smaller growth stocks, the options premium can be far larger as a percentage — but that’s because investors think those stocks could also conceivably double in a few months).
This strategy also works quite nicely for many people, though it’s harder to get decent premiums now with volatility relatively low for the large cap, blue chip type stocks, and you have to be willing to sell the stock without too much remorse. If Microsoft makes some giant deal that transforms the company over a weekend, and the stock opens at $55 and climbs to $65 or $70 by the time the option nears expiration, you have to be the kind of person who can handle selling it at $50 without smashing your laptop into pieces. You can always back out of a covered call sale by buying the call back at the market price to close the contract, but that obviously eats into or can destroy that income you had generated (you would also have to “buy to close” your covered call if you wanted to sell your shares of the underlying stock before the expiration date for any reason).
And yes, having relatively large positions in a stock helps with covered call selling — you need to have at least 100 shares to sell a covered call, but depending on the broker you use you might also find that commissions are a much smaller drag on your income if you sell 10 or 20 covered calls instead of selling just one. Almost all options contracts are for 100 shares, so the quoted option price is multiplied by 100 to get the “real” price of trading one contract — and that means you have to own 100 shares for each “covered” call option you wish to sell, since your shares are what is “covering” that obligation you’re entering as an option seller.
Have a headache yet? Sorry, me too. And if you want to add to the trading and to the nickel-and-diming you do to boost your annual returns, you can always take it to the next level and trade around your portfolio positions over and over. Sell puts against a stock you like over and over every few months until the stock is put to you (selling a covered put, which you can do even in a retirement account, means you set aside the cash to cover your obligation to buy the stock at a lower price — selling a “naked” put means you’re using the borrowing capacity of your margin account to cover your possible obligation, so you can’t do that in an IRA because you can’t use margin in retirement accounts)… then, once you’ve bought that stock, you can sell covered calls against that holding every few months until the stock is called away. Repeat.
For a small investor in search of a hobby, that may well keep you as busy as your collection of vintage toasters — whether it brings you as much satisfaction and income is, of course, an open question. Oh, and keep track of your trades — all this short term in-and-out trading generates a lot of small short-term capital gains, which the tax man would like to know about if you’re doing it in a taxable account.
So there you have it — yes, you can “rent” your shares, sort of, and effectively sell someone else the right to profit from the movement of that stock for a set period of time. It’s not magical, and for the safest stocks and the most conservative strategies the income is not dramatic, but since you can roll over these kinds of options sales several times a year the income can add up. You really have to treat it like a business and not get too attached to stocks, since in a bull market those covered calls might well be exercised and you’ll sometimes do worse than you would have done by just holding the stock, but in a world of low interest rates selling covered call options does appeal to some folks as a way to boost income without taking huge risks.
Sound worthwhile to you? Is this the kind of trading you’d be interested in? Have favorite candidates for selling covered calls? Let us know with a comment below.