If I have all this stock just sitting there, how can I lend it out to people for short selling?

Question

Short sellers need to borrow stock in order to short sell. I understand they typically get this stock through a broker though some sort of arrangement where they pay interest.

I was wondering, how can an individual actually do the lending? Does anyone know any broker in Australia that allows you to do this?

Also secondly, is this a good idea? For most passive investors, they aren't even going to think about selling if the stock fell as they are in it for the long haul, so lending your stock out, wouldn't that just essentially be a risk free way to gain some money on the side?

How much money can you actually make from this? Will the borrower just pay you the cost of the stock at the present interest rate? Is the interest negotiated? Is there any sort of "borrowing" exchange that can facilitate this type of trade?

Answer 1

One alternative strategy you may want to consider is writing covered calls on the stock you have "just sitting there". This will allow you to earn a return (the premium from the calls) without necessarily having to give up your holding.

As a brief overview, "options" are derivatives that give the holder the right (or option) to buy or sell shares at a specified price. Holders of call options with a strike prike $x on a particular security have the right to purchase that security at the strike price $x. Conversely, holders of put options with a strike price of $x have the right to sell that security at the strike price $x. Always on the other side of a call or put option is a person that has sold the option, which is called "writing" the option. If this person writes a call option, then he will be obligated to sell a certain amount of stock (100 shares per contract) at the strike price if that option is exercised. A writer of a put option will be obligated to by 100 shares per contract at the strike price if that option is exercised.

Covered calls involve writing call contracts on stock that you own. For example, say you own 100 shares of AAPL, and that AAPL is currently trading for $330. You decide to write a Jan 21, 2012 call on these shares at a strike price of $340, earning you a premium of say $300.

Two things can now happen: if the price of AAPL is not at least $340 on January 21, then the options are "out of the money" and will expire unexercised (why exercise an option to buy at $340 when you can buy at the currently cheaper market price?). You keep your AAPL stock plus the $300 premium you earn. If, however, the price of AAPL is greater than $340, the option will be exercised and you will now be required to sell the shares you own at $340. You will earn a return of $10/share ($340-$330), plus the $300 premium from the call option. You still make out in the end, but have unfortunately incurred an opportunity cost, as had you not written the call option you would have been able to sell at the market price, which is higher than the $340 strike price.

Covered calls are considered relatively safe and conservative, however the strategy is most effective for stocks that are expected to stay within a relatively narrow price range for the duration of the contract. They do provide one option of earning additional money on stocks you are currently holding, albeit at the risk of giving up some returns if the stock price rises above the strike price.

Answer 2

Typically, as an individual, you can't just decide you want to lend out some securities. There is a lot of legalities that must take place in order to engage in such a transaction. It's a regulated industry and the contractual obligations that exist between borrower and seller are taken care of ahead of time by the broker with their client, prior to any actual transaction taking place.

http://en.wikipedia.org/wiki/Securities_lending

I say typically, becuase I'm guessing that if you are a large enough client and own a substantial block of shares (I really mean a lot) you may be in the unique position of being able to lend out. I'm not sure what the logistics of this would look like, but I think the brokerage house would approach you and negotiate a borrowing rate. In that situation, you may negotiate lending to the the brokerage house and not necessarily directly to the borrower.

Answer 3

You just disclosed that you are new investor to the stock market. I'd advise that you first understand investing a bit better, as most will advise that investors need to be above a certain level before picking individual stocks.

That said, most stocks trade in high enough volume and have low enough short interest that they don't fall under the category you seek. You want to first ask your broker if they have such a process, not all do. If so, they would need to provide you with the stocks that fall into this odd situation, specifically, the shares that have traders seeking to short the stock, but the stock is unavailable. Even then, the broker may have requirements that you don't fall into, minimum history with broker, minimum size account, etc. Worse, they are not likely to offer this for 100 shares, but may have a 1000 or higher share requirement. Are you willing to buy some obscure $50/sh priced stock to lend out at 1%/mo? The guy trying to short it is far smarter than both you and I, at least regarding this particular stock. This strategy is more appropriate for the 7 figure net worth investor.

If any reader has actual experience with this, I'm happy to hear it. This response is from my recollection of two articles I read about 3 years ago, coincidence they both were published within weeks of each other.

Answer 4

When you opened your brokerage account, you likely signed a consent form permitting your broker to lend out your securities to other customers (or firms).

This will be transparent to you until you receive a dividend, in which case you may receive a "payment in lieu of dividend" instead of an actual dividend (the person who borrowed and sold short the stock paid you the dividend rather than the company).

Your broker may pocket the money made from lending the securities or share some of it with you depending on their fee structures.

Typically you need a margin account for this to happen. If you want to prevent your broker from lending out your stock, you can sometimes achieve it by putting your stock in a 'cash' account.

Answer 5

Lending of securities is done by institutional investors and mutual funds. The costs of dealing with thousands of individual investors, small share blocks and the various screw-ups and drama associated with each individual are too high.

Like many exotic financial transactions, if you have to ask about it, you're probably not qualified to do it.