concentrated position
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myriam2222
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- Feb 26, 2015
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I don’t have the text you are referring to but I understand it is about hedging a concentrated position with a put to avoid the tax from an outright sale.
I would say that with the put
1) you delay taxes. So if you liquidate your position at the expiration of the put if it is in the money then you do have a taxable event, but later.
2) if you do not want to be faced with a taxable event at all then you can probably keep your shares even at the time the put arrives at maturity. What I mean through that is that if the put ends up being in the money, you could then buy some new shares to deliver to the seller of the put option. This transaction would result in a gain covering the losses you made on your long position from holding the stocks (so the hedge worked). This gain would be taxable. But the initial stocks themselves, you can keep them as they were. And if you want to maintain the hedge, you can buy a new put option.
Does this make sense?
I would say that with the put
1) you delay taxes. So if you liquidate your position at the expiration of the put if it is in the money then you do have a taxable event, but later.
2) if you do not want to be faced with a taxable event at all then you can probably keep your shares even at the time the put arrives at maturity. What I mean through that is that if the put ends up being in the money, you could then buy some new shares to deliver to the seller of the put option. This transaction would result in a gain covering the losses you made on your long position from holding the stocks (so the hedge worked). This gain would be taxable. But the initial stocks themselves, you can keep them as they were. And if you want to maintain the hedge, you can buy a new put option.
Does this make sense?
myriam2222
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- Feb 26, 2015
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if you have shares that you hedge with a put, then you have to buy a put. So as for the put, you are the buyer (you buy the option / the right to sell your shares at the strike price). If the put ends up being in the money, you sell your shares.
myriam2222
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- Feb 26, 2015
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I take an example of what I meant in part 2) of my answer above. But again this is subject to discussion. This is what I meant when I asked if this made sense, because maybe it is not allowed.
You bought some shares at $10 in 2002. Now they are worth $100. It is a concentrated position, meaning it represents way too much weight in your portfolio. But if you liquidate them now you will have to pay taxes on $90 of capital gains per share.
So you don’t want to sell. But the problem is, you don’t want that much exposure either.
So you will simply hedge your position by buying a put. You pay a premium and you get the option to sell each share at $100 in one year.
Now in one year your shares happen to be worth $90. So you are glad you bought a put. You exercise it. But you still don’t want to liquidate your portfolio because you don’t want to pay taxes. So you buy the equivalent amount of shares on the market at $90 and exercise your put at $100. You make a gain of $10 per share. On the other hand, your concentrated position is still there untouched and you lost $10 per share from it this year. Your net gain/loss for the year is 0 per share ( minus premium of the put to be precise). So the hedge was efficient.
You get taxed on your gain from the put because you made $10.
But your cumulated unrealized capital gain of now $80 per share on your concentrated position is still there untouched and untaxed.
Do you think this is allowed?
If not, then the idea of the put is simply to delay tax payment. It sets a fixed date when you have to liquidate your position because if the put is in the money, then you have to liquidate at maturity.
You bought some shares at $10 in 2002. Now they are worth $100. It is a concentrated position, meaning it represents way too much weight in your portfolio. But if you liquidate them now you will have to pay taxes on $90 of capital gains per share.
So you don’t want to sell. But the problem is, you don’t want that much exposure either.
So you will simply hedge your position by buying a put. You pay a premium and you get the option to sell each share at $100 in one year.
Now in one year your shares happen to be worth $90. So you are glad you bought a put. You exercise it. But you still don’t want to liquidate your portfolio because you don’t want to pay taxes. So you buy the equivalent amount of shares on the market at $90 and exercise your put at $100. You make a gain of $10 per share. On the other hand, your concentrated position is still there untouched and you lost $10 per share from it this year. Your net gain/loss for the year is 0 per share ( minus premium of the put to be precise). So the hedge was efficient.
You get taxed on your gain from the put because you made $10.
But your cumulated unrealized capital gain of now $80 per share on your concentrated position is still there untouched and untaxed.
Do you think this is allowed?
If not, then the idea of the put is simply to delay tax payment. It sets a fixed date when you have to liquidate your position because if the put is in the money, then you have to liquidate at maturity.
myriam2222
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- Feb 26, 2015
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Well yes the point is to avoid liquidating your position and generating a taxable event, but to still get rid of the risk you have on your concentrated position. But I am not sure if the taxable event can only be delayed until the maturity of the put or if you can do what i described above and then roll over the put (buy a new one at expiration of the first one and so on) to continue further like this.
Let’s see what everyone else says.
Hey guys, anyone would like to have a nice discussion on this?
Let’s see what everyone else says.
Hey guys, anyone would like to have a nice discussion on this?
I’m not goign to look at the 2014 exam answers yet to figure out what’s going in this question but i’ll provide a brief comment.
Buying a put does not exactly monetize the asset but does provide protection from downside risk which can be viewed as ‘locking in gains’. This might be guaranteeing the equitable gain without actually creating a taxable event through an all outright sale. Yes, the put option going into the money will create a taxable event but by no means does the investor have to exercise the put option. He/she could roll it into a future month.
Buying a put does not exactly monetize the asset but does provide protection from downside risk which can be viewed as ‘locking in gains’. This might be guaranteeing the equitable gain without actually creating a taxable event through an all outright sale. Yes, the put option going into the money will create a taxable event but by no means does the investor have to exercise the put option. He/she could roll it into a future month.
myriam2222
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- Feb 26, 2015
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Ok, the first part is fine. This was clear to me.
But I would like to discuss the part in bold: how can you avoid exercising the put option within loosing money if it is actually in the money? Can you roll it into a future period and save your gains for later?
I know it’s a lot of blabla but if you have time to read what I suggested above, I would appreciate having your opinion on this.
Thanks Galli!!
myriam2222
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- Feb 26, 2015
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I don’t think you need to open it. It’s just a general question about how far you can delay the liquidation of your concentrated position with a put.
If the put gets in the money:
1) can you buy shares on the market to sell them at the strike price, and keep your concentrated position untouched with unrealized gains untaxed?
or
2) do you have to realize the capital gains outstanding in your concentrated position?
That’s what Derswap07 and I are trying to figure out.
If the put gets in the money:
1) can you buy shares on the market to sell them at the strike price, and keep your concentrated position untouched with unrealized gains untaxed?
or
2) do you have to realize the capital gains outstanding in your concentrated position?
That’s what Derswap07 and I are trying to figure out.
I also deffer from opening the mock until a month later, but I have a different approach to this question.
i thought that the premium you pay for puts is added to the tax basis of the stock, or something along those lines (maybe my recall is not the best, so someone could pitch in). In other words you would not end up paying tax*putPremium if you exercise your put options.
i thought that the premium you pay for puts is added to the tax basis of the stock, or something along those lines (maybe my recall is not the best, so someone could pitch in). In other words you would not end up paying tax*putPremium if you exercise your put options.
If you’re speaking in generalities and not towards the specifics of the Mock Exam question:
1) Yes you could but if your position is concentrated you’re unlikely to have the cash on hand to double your position in order to satisfy the put exercise. This isn’t a logical solution
2) No you do not. You could just sell the put before expiration and pay the cap gains on the Put return. Buying a put gives you the right NOT obligation to sell.
What you guys are looking for is a general rule to something that depends on the specifics of the question. Back to the OPs question, if the put goes into the money you can either exercise the put and take the full cap gain on the concentrated position OR you can sell the put and only pay cap gains on the put. Again this is a general question towards a specific situation. In conclusion it largely depends on the circumstance and goals of the investor. hell it even matters what country this person resides in!