It is a question that is often asked by traders and investors who are relatively new to the realm of the stock market: Can earnings be made on stocks without selling the stocks outright? The answer to this question is yes. Different mechanisms can be leveraged to gain earnings on stocks without selling them, especially if you are planning on holding the stocks for the long term.
Stocks can be effectively monetized through methods like dividends, collateralizing for loans, or using cash-futures arbitrage. All of the methods listed above are applicable for earning a passive income while holding onto the actual stocks. By not selling stocks for short-term gains and by using these methods, traders can consistently earn a yield from the stocks that they hold and can book profits in the future when the stocks appreciate.
Dividends: A Source of Passive Income
A dividend is a portion of the company’s profits distributed among its shareholders. Certain companies have a policy of providing dividends on their stocks, so buying these stocks entitles you to access their dividends. Dividends are typically paid out as cash payments. Having ownership of a dividend-paying stock means that the investor has access to a passive income or earnings at all times as long as the investor holds the stock in their portfolio.
Dividends are a form of payment, which means that by collecting dividends, your stock share does not depreciate. If you held 100 stocks of NVDIA, after collecting the dividends, the number of stocks in your portfolio will remain the same, in this example, 100. Capital appreciation is yet another benefit of having dividend-paying stocks in your portfolio. Just because you collected dividends on a stock, it does not deprive you of the privilege of booking profits on a later stage when the stock appreciates.
Some companies pay dividends in the form of additional stocks or properties (rarely). When dividends are paid out as stocks, investors usually keep them added to their portfolio for a compounding effect, thus earning more dividends. The power to make a decision to pay dividends remains solely with the company. Companies often do not go back on their dividend policy.
Unlocking Portfolio Value Through Regulated Securities Lending
Another way in which you can earn from your stocks without selling them is through the fully paid securities lending (FPSL). The FPSL mechanism is designed in such a way that the value from a portfolio can be unlocked without selling the underlying stocks. This is an exchange-regulated mechanism. Through this, investors can temporarily transfer their shares to other market participants. These participants typically consist of short sellers who want to fulfill trading strategies or settlement obligations.
The FPSL mechanism operates as an order-driven market, which is very close to normal stock trading. Here, the lending and borrowing are matched on a price-time priority. This lending-borrowing mechanism is for a fixed tenure. FPSL tenures are open-ended and can be terminated either by borrower or lender at any time.
In the FPSL mechanism in the US, the collateral is typically cash or US Securities. The normal collateral ratio is a minimum of 102% of the stock market value of the lent securities. In order to safeguard the lender from defaulters, the borrower’s collateral is highly liquid. In the FPSL mechanism, the earning potential varies according to the demand for the stock, its volatility, the brokerage’s fee split, and the current interest rates on collateral.
The Fundamentals of Cash-Futures Arbitrage
This mechanism, called the cash-futures arbitrage, is a sophisticated but market-neutral method to earn income from your stocks without selling them. This is normally practiced by high-net-worth individuals(HNIs). This mechanism is a near risk-free method to gain returns on one’s stocks.
This mechanism exploits the price discrepancy between a stock’s current market price (Cash Market) and its projected future price (Derivatives Market). Through this method, an investor can lock-in on a guaranteed profit called the spread. This profit is acquired whether the market moves up or down.
Cash-futures arbitrage is possible only in a healthy contango market. A contango market is one where the stock’s futures contract price is higher than the spot market price. This discrepancy exists in the market because of factors like interest rates and the time value of money.
This is a mechanism that involves an investor opening a short position in the stock futures market while holding onto the stocks in the spot market. As the futures contract expires, the prices will become the same, and the investor will lock in the initial spread as the profit.
