forward conversion with option

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sachin_patel

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is it a perfect hedge? should it be taxed as a sale? (if not, why not?)
Thanks,
 
its not a perfect hedge becuase options have non-linear sensitivites (gamma).
it sohuld not be taxed becauset here was no sale of the underlying….if any of the options expire in the money and are exercised, thoseoptions will be taxed at that time
 
ok just thought about answer to my own question.
you are just locking in price not getting paid for any of those.
so when you exercise option or when forward matures is when payoff happens, thats when the tax liabilities will be created..
i guess?
 
dwheats wrote:
its not a perfect hedge becuase options have non-linear sensitivites (gamma).
it sohuld not be taxed becauset here was no sale of the underlying….if any of the options expire in the money and are exercised, thoseoptions will be taxed at that time
Click to expand...
got it.. thanks!
 
for equity forward contract, the “perfect hedge” depends on what the underlying security is, and what is being hedged.
if the forwards are specific to one stock, and you are hedging that stock specifically, yes, it is a perfect hedge.
if you are using S&P futures/forwards to hedge a diversified portfolio that does not have the same composition as the S&P, then no, not a perfect hedge
 
dwheats wrote:
its not a perfect hedge becuase options have non-linear sensitivites (gamma).
Click to expand...
Per the CFA text R12 pg. 345 the position created with a FCwO + underlying is riskless and will earn Rf.
 
Cubemonkey wrote:
dwheats wrote:
its not a perfect hedge becuase options have non-linear sensitivites (gamma).
Click to expand...
Per the CFA text R12 pg. 345 the position created with a FCwO + underlying is riskless and will earn Rf.
Click to expand...
you’re right. im still having a tough time calling it perfectly hedged becuase that implies that the position has 100% perfect negative correlation with the initial position. and if you the underlying moves, then the call options move, but not by the same amount, and you cannot necessarily unqind your position at the initial value if you get what im saying….
so if for some reason you have a liquidity need and need to unwind, you cannot realize exactly the amount at which you had when you first implmented the hedge
 
Yeah i understood your issue when I was replying to you. I agree with your concern about the wording, but I don’t think it will be relevant on test day. I don’t think CFA text refers to it as a hedge for this reason.
For anyone else reading: A FCwO isn’t really a hedge in the way some professionals think of it. In this context, just think of it as locking in a value for a position so that you can monetize it with a high loan-to-value.
 
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