You can “rent-to-own” your shares, creating cash flow on stocks you already own. How? Using a stock option strategy known as “covered calls.”
We’ll explain covered calls a little below, but you can also check out Options for Beginners Part 2 and Part 3 to get a better understanding of this strategy.
If you’re a real estate investor, it may help to think of covered calls like a rent-to-own deal. Let’s dive in…
What is Rent-to-Own?
Rent-to-own is a unique real estate investing strategy that allows you to make money in several different ways.
- Find a tenant buyer who can’t quite qualify for a home, but they have some funds saved up for a down payment.
- Find a property that you (or a partner) qualify to get a mortgage on.
- The tenant buyer pays you an “option consideration” up front. This is their share of the down payment.
- Each month, they rent the property from you, plus pay you a monthly premium that is credited towards the purchase of the house.
- You and the tenant enter an option agreement that allows the tenant buyer to buy the house from you in 2 – 3 years at a pre-set purchase price.
- You make money on the up front option consideration, monthly rent premiums, and the sale of the house.
Covered calls are similar.
What is a Covered Call?
A “call” is an option contract. The buyer of the contract wants the right to buy stock at a specific price (strike price) by a specific date (expiry date). For that right, they pay the call seller a premium up front.
To properly profit in this transaction, you want to be the seller of the cover call contract.
For example:
- You own shares of XYZ at $93. Maybe you’re willing to sell those shares at $107. So you sell a covered call with a $107 strike price that expires in 31 days.
- For the right to buy your XYZ shares at $107, the call buyer will pay you a premium up front. Let’s say the premium is $0.50 per share.
- Because every option contract is for 100 shares, that is a $50 premium that you receive up front.
- If the price of XYZ stock reaches $107 when the expiry date comes, your shares will get “called away,” which means you sell them at the strike price.
NOTE: This strategy is a part of what we call “Stock Hacking.” It can be a solid side hustle if you know what you’re doing!
How Rent-to-Own is similar to Covered Calls
You may already see some similarities between Rent-to-Own and covered calls.
Purchase Price / Strike Price
The agreed upon future purchase price for your Rent-to-Own property is similar to the strike price you set for your covered call. You’re promising to sell you property and your shares at a specific price.
Option Term / Expiry Date
The term of a Rent-to-Own is typically 2 – 3 years. Covered calls can be anywhere from one day long to many years long. Either way, there is a set timeline for action to be taken.
Option Consideration / Call Premium
Although the option consideration you receive up front for a Rent-to-Own is technically supposed to be credited to the tenant buyer’s future purchase, it’s still cash that you receive up front.
The covered call premium is yours no matter if your shares are called away or not.
Underlying Asset
Both your Rent-to-Own and covered call are “covered” by an underlying asset. If the contracts fail to carry through, in either strategy, you keep the asset and can enter another contract if you wish.
How do you cash flow on stocks with covered calls?
Just like your Rent-to-Own, covered calls let you make money in a couple ways.
- The call premium is cash in your account right away.
- If your shares are called away, you profit from the sale (as long as you set your strike price high enough).
- If your shares aren’t called away, you keep the premium and you can sell another covered call.
In this way, if you keep selling covered calls without selling your shares, you create cash flow with the premiums you collect.
Now, yes, you can leave money on the table if the stock price skyrockets, but as long as you set your strike price high enough, you are still making good money.
BONUS TIP: You can sell covered calls in your TFSA or RRSP! So the premiums you collect could be tax free income!
What do I do with this information?
Take the time to wrap your head around these concepts. Revisit our Options for Beginners series to get a better understanding of stock option basics.
If you want to see how stock options perform compared to real estate (and 2 other popular side hustles), then download “The Ultimate Side Hustle for Canadians.”
It’s a FREE case study we compiled with a by-the-numbers breakdown of 4 popular side hustles: Real estate, stock options, MLM and Amazon ecommerce.
There are many parallels between real estate and stock option trading. We’ll continue to publish articles that compare the two wealth building strategies. Hopefully it helps you grasp the power of stock options to accelerate you to financial freedom.
Until then, happy trading!
🍒Cherry & Erwin
P.S. If you’re interested in finding a new side hustle, we’ve put together a new case study that examines the four most popular side hustles for passive income in Canada. You can download this case study for FREE right now if you sign up for our email newsletter.
