Options as insurance
- Thread starter Haley
- Start date
Absolutely, to help explain:
Provide an example of underlying stock.
How much you want to protect for the downside.
When bought.
Of course for this to be an issue it has to be in a taxable account - worth double checking that point, and if so, Total Fed/State/City tax rate
You can make up random numbers to increase privacy.
Provide an example of underlying stock.
How much you want to protect for the downside.
When bought.
Of course for this to be an issue it has to be in a taxable account - worth double checking that point, and if so, Total Fed/State/City tax rate
You can make up random numbers to increase privacy.
Haley
I am not a robot
Apple
Would like to protect: in shares or $? I'm guessing shares, 2 x 100, maybe 2.5 (after it splits next month). It is almost painful to even think about limiting the upside, so I just keep repeating 'lock in the profit' to myself. $ is easy to figure because...When bought: in 2002-2004.
Texas, so no State/local tax, just Fed taxes @ 28%. So long as we don't take much in cap gains.
I just remembered we have to decide where to land the 401k too.
Would like to protect: in shares or $? I'm guessing shares, 2 x 100, maybe 2.5 (after it splits next month). It is almost painful to even think about limiting the upside, so I just keep repeating 'lock in the profit' to myself. $ is easy to figure because...When bought: in 2002-2004.
Texas, so no State/local tax, just Fed taxes @ 28%. So long as we don't take much in cap gains.
I just remembered we have to decide where to land the 401k too.
Hi Haley,
Thanks for the information - to run the math what I meant was how much to protect against downside risk?
Today the price is $606, how much of that do you want to protect against a swing downward? Protecting a stock like that all the way back to your 2002-2004 prices won't make financial sense, there is just too much appreciation. If you wanted to protect $100 or so perhaps...
However, since you are already into Long Term Cap gains it might be better to just start selling it - I would use options to defer it from Short Term (taxed at income rates) to Long Term (you are only looking at 15% if you are in the 28% bracket).
Tax arbitrage may exist if you were going to drop to $0 salary next year and therefore enter a 0% cap gains rate, but the options contract price may make that prohibitive. Is something like that occurring in your scenario?
Thanks for the information - to run the math what I meant was how much to protect against downside risk?
Today the price is $606, how much of that do you want to protect against a swing downward? Protecting a stock like that all the way back to your 2002-2004 prices won't make financial sense, there is just too much appreciation. If you wanted to protect $100 or so perhaps...
However, since you are already into Long Term Cap gains it might be better to just start selling it - I would use options to defer it from Short Term (taxed at income rates) to Long Term (you are only looking at 15% if you are in the 28% bracket).
Tax arbitrage may exist if you were going to drop to $0 salary next year and therefore enter a 0% cap gains rate, but the options contract price may make that prohibitive. Is something like that occurring in your scenario?
Haley
I am not a robot
I thought the 15% rate was gone. I guess not 
If we filed married filing separately and give my husband all his earnings and all dividends, and then have me take only my paltry earned income and Capitol gains would they be 0%, if I can get my income low enough? Could I also take the child tax credits that have been phased out for us and itemize all our health costs (we don't make it to 10%, but pretty close), or is that not allowed? Could I open an IRA with after tax money?
I'd have to run several variations to see if it makes sense, his tax rate would be higher but the child tax credit alone would off set $1,000. I'm pretty sure there are other credits we are phased out of. If I can open an IRA at a lower tax rate it would be pretty valuable since the majority of our IRA funds are going to be taxable in retirement, the way things currently stand.
Back to the original question about options, because my spouse likes a heavily tech weighted portfolio, how much, roughly, would it cost to protect 100 shares for $100? Is the cost pretty linear, if we want to do 10x that? We can build the cost of the option into the cost basis, right?
So many questions
We have always been aggressive savers, but we have a very incomplete understanding of how to best handle the nest egg.
If we filed married filing separately and give my husband all his earnings and all dividends, and then have me take only my paltry earned income and Capitol gains would they be 0%, if I can get my income low enough? Could I also take the child tax credits that have been phased out for us and itemize all our health costs (we don't make it to 10%, but pretty close), or is that not allowed? Could I open an IRA with after tax money?
I'd have to run several variations to see if it makes sense, his tax rate would be higher but the child tax credit alone would off set $1,000. I'm pretty sure there are other credits we are phased out of. If I can open an IRA at a lower tax rate it would be pretty valuable since the majority of our IRA funds are going to be taxable in retirement, the way things currently stand.
Back to the original question about options, because my spouse likes a heavily tech weighted portfolio, how much, roughly, would it cost to protect 100 shares for $100? Is the cost pretty linear, if we want to do 10x that? We can build the cost of the option into the cost basis, right?
So many questions
We have always been aggressive savers, but we have a very incomplete understanding of how to best handle the nest egg.
I thought the 15% rate was gone. I guess not
If we filed married filing separately and give my husband all his earnings and all dividends, and then have me take only my paltry earned income and Capitol gains would they be 0%, if I can get my income low enough? Could I also take the child tax credits that have been phased out for us and itemize all our health costs (we don't make it to 10%, but pretty close), or is that not allowed? Could I open an IRA with after tax money?
I'd have to run several variations to see if it makes sense, his tax rate would be higher but the child tax credit alone would off set $1,000. I'm pretty sure there are other credits we are phased out of. If I can open an IRA at a lower tax rate it would be pretty valuable since the majority of our IRA funds are going to be taxable in retirement, the way things currently stand.
Back to the original question about options, because my spouse likes a heavily tech weighted portfolio, how much, roughly, would it cost to protect 100 shares for $100? Is the cost pretty linear, if we want to do 10x that? We can build the cost of the option into the cost basis, right?
So many questions
We have always been aggressive savers, but we have a very incomplete understanding of how to best handle the nest egg.
Married filing separately can be a way to drop the income for capital gains, but when you do this you lose a lot of deductions and perks. I'm not sure about the Child Credit, but many things will go away. Also, do you own the stock yourself or jointly? If it is in your name then it could be possible, but if jointly held then i'm not so sure.
Options are priced with intrinsic value and time value. So if you wanted $100 value plus 6 months duration the price would be the same for 1 or 1000 contracts. However, once you start playing with the intrinsic value or time value variables the prices change a lot. Honestly, $100 of protection will not be cheap.
You can see the prices here: https://www.google.com/finance/option_chain?q=NASDAQ:AAPL&ei=HzF-U4GsG8r46gGAv4CQDQ
If you look at October $605 Puts they cost $32.45 each. They trade in 100 stock blocks, so 1 contract protects 100 shares and would cost you $32.45x100 or $3,245 to purchase.
That would protect them all the way down to zero.
If you wanted to protect them just for $100 then what you would do is create a bear put spread:
- Buy Oct $605 Put for cost of -$3245 (per contract)
- Selling a $505 Put for income of $380 (per contract)
Basis and Options
Don't build the price of the option into the basis of the stock - treat both the stock and the option as independent trades. When all is said and done it will equate to the same thing, but it becomes very difficult to track otherwise.
I wrote about it in a post too, perhaps you saw it? http://saverocity.com/finance/tax-arbitrage-using-put-options/
Really though, if you are talking about a solid amount of capital gain here, you should certainly get in touch with CPA to discuss.
Tom McGhee
Level 2 Member
Keep in mind with the cash that Apple has on hand, they could buy 50 cruise ships, run them aground in Italy, and still have $100 million left over to screw up another 2 times.
fulthrust7
Level 2 Member
To sell or to hold AAPL (currently)?
Haley
I am not a robot
That is the question. But only because I'm way over weighted in this single stock. It just hit a 52 week high.
It is going to get even more volatile/reactive once the split goes into effect.
WWDC starts Monday, German leak, Beats deal, fun fun fun.
shootenducs
Level 2 Member
How many shares? Why not sell some to lock in a profit, maybe even enough to cover your original costs. Then also do the bear put spread that Matt pointed out above. That way you will have best of both worlds.
You can sell January 2015 at the money call and buy January 2015 at the money put. In this way, you are synthetically sold your shares.
Hmm.. can you break that down a little further? I think many people might get tripped up by what you suggest.
Assume there is 100 shares of aapl in the portfolio. At today's closing, AAPL share price is $644.82. Jan 17 2015 $650 strike call option price is $43.50 and Jan 17 2015 $650 put option price is $52.7. bid ask spread is ignored for simplification.
Instead of selling 100 shares of aapl directly today which can incur income tax in 2014, op can elect to buy a Jan 17 2015 $650 strike put option @$52.7 and sell a Jan 17 2015 $650 strike call option @$43.50. op has to pay for this trade (52.7-43.50) x100=$920.
After the trade, the portfolio is as following:
100 shares of aapl
+1 Jan 17 2015 $650 put
-1 Jan 17 2015 $650 call
By the option expiration day, if aapl price is > $650, your shares will be called away at price $650/share since you shorted a call; if aapl price is <$650, you can exercise Jan 17 2015 $650 put option and sell the price at @$650/share.
either way, the share was sold at $650/share.
Instead of selling 100 shares of aapl directly today which can incur income tax in 2014, op can elect to buy a Jan 17 2015 $650 strike put option @$52.7 and sell a Jan 17 2015 $650 strike call option @$43.50. op has to pay for this trade (52.7-43.50) x100=$920.
After the trade, the portfolio is as following:
100 shares of aapl
+1 Jan 17 2015 $650 put
-1 Jan 17 2015 $650 call
By the option expiration day, if aapl price is > $650, your shares will be called away at price $650/share since you shorted a call; if aapl price is <$650, you can exercise Jan 17 2015 $650 put option and sell the price at @$650/share.
either way, the share was sold at $650/share.
Excellent. I like it. I personally went with a bear put spread because your trade will require a transaction, unless it's at exactly $650- great to defer capital gain. Mine cost a little more but didn't cap the upside, because the basis is already into LTCG and therefore I wasn't focused on the lock in.
I like this approach you outline and think it's great for deferring STCG effectively, and it's also a valid solution to this situation.
Thanks for breaking it down- I'm sure it is more helpful to others like this.
shootenducs
Level 2 Member
Matt could you talk about hedging/protecting your portfolio with puts in a general sense and specifically if your investing in index funds?
Sure, I'll write up a post when I get a moment.
Generally speaking I dislike puts as a hedge. They are too crude and too costly- especially against the market.
I can see value in them to extend short term capital gains and turn them into long term, but other than that they really are only valuable against very narrow positions with high volatility.
Of course, some may argue that all data is baked into a stock price already, but I personally believe that a stock will move in reaction to an event.
As an example Tmobile and Sprint- holders of t mobile may want to put option insure up to the day of M&A approval.
However - covering the entire market is madness- there are too many variables and it's just too costly. Instead hedging should be done by asset allocation- if you can, by buying more of a 'less correlated' asset- eg if you hold $100k in stock- buying $50k of bonds may create a hedge- and if you hold them to maturity you won't lose money (on the Bonds)
The premium cost of options will outweigh the tax hit of long term cap gains over time.
Best hedge- buy more of other assets
Next best- sell positions and use money to reallocate into other assets
Next best - sell some and keep it in cash
Next best - options
I will repeat- your personal circumstances matter a lot here- salary to net worth ratios are critical, so the advice is general.
Happy to explain more if it helps.
shootenducs
Level 2 Member
Thanks for the info.
What asset classes do you recommend?
What asset classes do you recommend?