What are Renters?
While investing and/or trading, you may hear people talking about renters. What are they?
In short, it is stock against which the holder is selling covered calls and collecting premium.
For those unfamiliar with a covered call, it is a call option that someone sells that is covered by shares of stock that they own.
The seller of the covered call collects the premium that it sells for. After which, the seller is then obligated to sell the stock to the buyer of the option, if the option is exercised. Options are typically only exercised if the price of the stock is at or above the strike price at the time of expiration.
So, how does this work?
First, you need blocks of 100 shares of stocks in a symbol that has options available. (For most options, each contract is for 100 shares of a stock.)
Second, you must be willing to part with the stock if it hits or passes the strike price or be willing to buy back the contract. (For the latter, I will get into that in a future lesson.)
Third, you must have the basic level of options trading enabled for your account, which allows you to sell covered calls. (See your account information with your broker to know your authorized level of trading.)
So, if I have 100 shares of XYZ, it is optionable, and my plan does not require me to hold it, nor does it require that I sell it soon, letting it become a renter is a possibility.
[NOTE: Specifics on how to enter the trade on your platform varies. Please see the appropriate help pages and instructions for how to make the trade on your platform.]
When I sell a covered call, I take the following into account:
- At what price did I buy the shares I am writing the call for?
- What is the current price of the stock?
- What timeframes are available for selling the call (does it offer weeklies, or only monthlies, as choices for option expiration)?
- How much do I believe the stock will move in the timeframe before option expiration?
- How much premium can I get with the different timeframes and strike prices?
- Do I want to try to hang onto it for another cycle, or do I want to try to let it go and collect the ‘last’ of my profits in this contract?
As a general rule of thumb, I always sell the option at a strike price at or above what I bought the shares for. Like everyone, I always want to make profit.
But, how can I make profit if I sell the stock for the price I bought it? When I sell the contract, I collect the premium that someone is willing to pay for it. No matter what, I get to pocket this money in the transaction. So, even if the contract is executed at that price, I still make the money I received from the premium.
Now, back to our fictional XYZ. Say I bought the stock at $50/share. The current price is $55, and only monthlies are available in the options chain. I believe this stock is worth holding, but I don’t feel as if I’m beholden to keep it if I can make a good profit. So, as I’m looking at what contracts, I want to try to put the strike price a little out of the expected move for the next month. The strike prices for the options are also in $5 increments (50, 55, 60, 65, …).
When I look back at the charts, I see that the stock typically stays within a $7 range within any given month. Now, also keep in mind that the market often prices this in when it comes to volatility, meaning that any options with strike prices outside of an expected move will have less premium. But, as my goal is to collect rent (hopefully over and over again), and keep the stock as it goes up, this is acceptable.
So, as I look at the charts, I am looking to sell a covered call with a strike price of $65 in the next options expiration date. Now, you see that the current bid/ask is 0.15/0.20. You can put your order in for that range, or you can set a GTC (good ‘til cancel) order that can try to fill at a price you choose. That is up to you.
But, in this case, say you put in an order at the ask and are filled at 0.20. What this means is that you got $0.20/share, or a total of $20 for the contract. No matter what happens, this is yours to keep. If the stock is under $65 at expiration and the contract is worthless, you get to keep both that premium and the stock and can sell a new contract for the next monthly cycle.
If the stock climbs over $65 and the contract is executed, you not only keep the $20 of premium, but you also pocketed another $15/share of profit.
Now, like any trading or investing, there are some risks, such as:
- While the shares are tied up in a covered call, you cannot sell them. If the stock dives, you cannot unload them until you buy back your call (which should be cheaper now).
- The stock can jump substantially, and you lose out on potential profit. For instance, what if it jumped to $70? That means that you have $5/share of profit that you didn’t make because of the call. For this side of the risk, I look to not let FOMO (Fear Of Missing Out) determine what I am going to do.
Now, something else to keep in mind is, what is your new break even price?
In this example, I made a $0.20 premium for every share, so my new break-even price on the stock is: 50.00 – 0.20 = 49.80.
If you are able to do this long enough against a position, your break-even price can get to $0.
In practice
I just started with this strategy fairly recently for some of the holdings I have. Given that I am still working with small accounts, I don’t have a large number of positions I can do this with.
One thing to pay attention to is the options volume for your ticker. The higher the typical volume, the easier it is to get filled at a price you like. But, the lower the volume, the more difficult it is, and you may need to ‘settle’ when it comes to your premium. For a couple of these, I’m basically pulling in a few pennies/share in a week in premium, but those are my pennies, and over the course of a year, it will add up.
Since the beginning of September, I have been able to get pretty good returns on stocks that I didn’t have to sell and don’t collect dividends.
My returns for the 6 positions I am ‘renting out’ are: 5.5%, 22.3%, 47.9%, 19.3%, 21.5%, and 15.8%. (About half of the positions were acquired after September 1st.)
That means that my ‘break-even’ price on any of these positions is that much lower than my purchase price. Additionally, the strike prices I have been choosing typically give me an additional 20% or more profit from the original buy price, should they get executed.
Not every position will reap huge percentages. It comes down to your strategy and your plan. But, as I have heard often, how do you put the odds in your favor? Though this won’t double your portfolio overnight, it can achieve steady gains.