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How to make money without selling your stocks
N Mahalakshmi and Vikram Srivastava |
April 01, 2004
Equities are proven to be the best performing asset class over the long-term. But the idea of long-term investing doesn't quite appeal to a large section of investors.
This is because you can never be sure of how long it could take for your stocks to achieve the required price target. And during the waiting period, you earn nothing unless the stock pays decent dividends.
But what if one says that you can see money flowing in even as you hold on to your favourite stocks? There are quite a few ways to make your shares churn up money for you even as you hold on to them.
Say 'yes' to lending: Stock lending is a risk-free way to earn that extra bit from your existing shares. To lend your shares, you must register yourself with one of the approved intermediaries like the Stock Holding Corporation of India (SHCIL) under which you agree to offer your shares for lending. The intermediary will approach you whenever there is a demand for shares.
If you agree to lend, you have to enter into an agreement with the intermediary with specific details like the time period for which you are willing to lend, the rate of interest payable and so on. Your shares are then transferred into a pool account and are disbursed to borrowers on behalf of the approved intermediary.
The risk associated with lending is that of the borrower becoming insolvent and being unable to repay the securities borrowed, or price fluctuations of the scrip in the market.
But intermediaries generally monitor loan and collateral values daily to minimise such risk. The lender does not face any risk as all the risks associated with lending of securities after creating a 'pool account' is borne by the intermediary.
Currently, SHCIL offers around 8 per cent returns, on an average, to lenders. But the returns can vary depending on the demand-supply situation. After lending your shares, you can also recall them without any charges.
Lock your profits: While buying futures contracts or borrowing against shares to buy more equities may make sense in a market trending upwards, the problem arises when the market is in a trading range. Here, as an owner of shares you can exploit arbitrage opportunities.
With the comfort of holding shares, you can move between the NSE and BSE to capture price mismatches. In effect, sell shares where the going price is higher and buy where it is lower.
Though the uniform settlement cycle across all stocks exchanges has lowered arbitrage opportunities drastically, inefficiencies still exist. Prices on various bourses vary due to demand-supply mismatches.
Arbitrage can be effectively employed in the derivatives markets, too. Since there are several imperfections in the market, stock futures are often mispriced. Many times stock futures trade at a discount to the underlying stock.
In such a scenario, you can sell the stock in the cash market and buy it in the futures market. Since the cash and futures price tend to converge as contracts get closer to expiry, you can reverse the transaction by selling futures and buying stocks in the cash market.
This transaction needs to be reversed as futures transactions are currently settled in cash. If and when the market moves to physical settlement, you will get the shares straight away without having to reverse the transaction.
Since you have to pay only a margin and not the full amount to buy a futures contract, the cash in excess of the margin can be deployed in a debt instrument.
Writing covered call options
Let the money flow: Another way to make money while you hold your shares is by writing options. The option writer earns a premium for the risk he undertakes by offering to buy (put option) or sell (call option) shares at a pre-determined price.
Option writing is not really risky. Technically for an option writer, the profits are limited to the extent of the premium income. However, the losses could be unlimited if the price moves against you.
In other words, if the cash price moves beyond the strike price, the option is likely to be exercised which means you incur a loss as an option writer.
However, if you own the shares, you actually part with the returns you would have made on the underlying stock had you not written an option. Writing call options while you hold the shares is called a covered call strategy.
The purpose of covered calls is to convert the uncertain but large capital gains into certain but small gains. Covered call is always with reference to an individual stock and not with reference to a portfolio.
Though it can be implemented at the portfolio level, the payoff profile of covered calls for a portfolio is not attractive because of mathematical relationships in option prices, say experts.
A covered call strategy involves holding a stock in the long-term and writing call options of shorter maturity, and writing them regularly. The idea of a covered call is to write an option which is unlikely to be exercised while you hold the shares. Your gain is the premium you get on selling the contract.
Borrowing against shares
Borrow to buy stocks, if you are a bull: Loans are available in plenty these days. But despite the steep reduction in overall interest rates, personal loans don't come cheap. No matter what banks claim, the lowest rate of interest on personal loans not supported by collateral security is 18 per cent.
But your cost of funds can become substantially cheaper if you provide collaterals. And many banks now accept shares as collateral. So if you are cash strapped, you can make good use of the shares sleeping in your demat account and avail of cheap loans to take care of your financial needs.
Usually, loans against shares carry a rate of interest ranging anywhere between 11 - 15 per cent. The actual interest charged on the loan depends on the amount you borrow and the quality of shares you give as collateral.
As a matter of fact you can't get a loan against any share you hold. Banks are generally conservative and prefer to lend only against good quality scrips. Out of the 6000-odd shares listed on the Indian bourses, banks only lend against 150-odd shares.
For top-rated stocks like Infosys and Hindustan Lever, banks are normally willing to give loans against individual shares. But in case of lower-rated stocks, they generally ask you to produce a basket of stocks. As per guidelines, banks are supposed to maintain a margin of 40 per cent for loans granted against shares.
The bank would monitor the value of your stocks on a daily basis. And if the collateral value falls short while you have fully utilised the overdraft, you are asked to provide additional margin within 48 hours.
This can be in the form of cash, or additional shares. If you fail to cough up the margin amount, the banks are free to sell your shares in the market.
Borrowing against shares is a good way to lower the cost of your overall borrowings. You can convert your existing high-cost personal loans into low-cost loans by providing shares as collateral.
And if you are really street smart, you can consider deploying this money back into equities. However, such a strategy would work for you only if the return on the stock is exemplary.
You can also consider this strategy as an alternative to buy in the futures market. Typically, if the mood is bullish, the futures price may be much higher than the fair value of the contract (cash price plus cost of carry) and hence, makes it a more expensive option.
So it might be a good idea to look for cheaper money to fund your purchases. However, the minimum amount you must borrow against shares is Rs 50,000 and the maximum limit is Rs 500,000. So go ahead, get more out of your stocks.