Author Topic: Hedging exposure  (Read 4453 times)

ERICOPOLY

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Re: Hedging exposure
« Reply #10 on: March 21, 2020, 09:33:14 PM »

(Also you can create a similar position by keeping the long stock position, taking out a margin loan against 50% of the position, and buying a put option to protect your downside from a margin call. So, multiple ways to extract cash from a long position while maintaining identical exposure.)


This is the second time in a week I've seen it mentioned to buy a put in conjunction with margin borrowing to avoid margin calls.

So in case somebody without margin experience is going to try this...

... make SURE your account is configured for "portfolio margin" and not "Reg-T margin".  Or else you'll come to regret it at the worst time.



ERICOPOLY

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Re: Hedging exposure
« Reply #11 on: March 21, 2020, 09:46:38 PM »
So maybe there was some really good thing about naked short selling that nobody told me about...

Section 1.1233-1(a)(1) of the Income Tax Regulations provides that, for income
tax purposes, a short sale is not deemed to be consummated until delivery of property
to close the short sale.


So, potentially, a naked short sale would not be a constructive sale.  Maybe that's why naked shorting was hard to squash in a constructive sale world.

ERICOPOLY

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Re: Hedging exposure
« Reply #12 on: March 21, 2020, 09:55:38 PM »
So let's say you're a hedge fund and you're trading in FFH or OSTK, and this is like 15 years ago.  Yeah, like, totally.

Step 1:  You drive the stock down on rumors you've spread that they'll go bankrupt... 
Step 2:  You buy and spread rumors that the company is amazing
Step 3:  You naked short to hedge your gains without triggering constructive sale (because you aren't delivering the shares)
Step 4:  Back to step 1 ad finiitum ad nauseum

A stack overflow exception occurs: 
https://www.deseret.com/2013/1/17/20512752/overstock-ceo-arrested-for-having-gun-in-luggage-airport-police-say#one-of-the-banned-items-discovered-by-transportation-security-administration-officers-at-a-security-checkpoint-at-salt-lake-international-airport-in-january-2013


LC

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Re: Hedging exposure
« Reply #13 on: March 21, 2020, 10:00:42 PM »
Oh man I forgot about that gem:

"Patrick was traveling and packed a bag that he hadn't used in quite some time," said Overstock President Jonathan Johnson. "He didn't realize that he had left a gun in the bag."


"It was an innocent mistake," he said. "He was in a hurry to catch a plane and packed a bag he hadn't used before. It hasn't happened before and hopefully won't happen again."


What a hero  ;D ;D

"Lethargy bordering on sloth remains the cornerstone of our investment style."
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ERICOPOLY

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Re: Hedging exposure
« Reply #14 on: March 21, 2020, 10:42:58 PM »
Selling short or buying put options on GOOGL as a way to hedge a long GOOG position would probably be considered a constructive sale (i.e. no different than if you just sold GOOG).

You should look for tech-focused ETFs that closely track GOOG, something like XLK, VGT, IYW, FTEC...

I'm pretty sure you're right about selling short to hedge...

... but I don't think you're right about buying a put to hedge, because there is still the capacity for upside potential.  Because there is the capacity for upside potential, the IRS cannot argue that it is functionally the same thing as selling the stock.  But I do believe it can restart the holding period clock in terms of short vs long capital gains treatment.

If you simultaneously write ATM calls to pay for ATM puts, they'll likely rule that a constructive sale.  Even so, if you reverse the transaction after the stock drops a lot, and you do so within the time period rules, you don't trigger the sale but you have restarted the capital gains clock and you're back to waiting 12 months for long term treatment.

I'm not positive on the put option. Selling calls and buying puts is certainly closer because the payoff curve is identical. According to this: https://www.fidelity.com/viewpoints/active-investor/protect-your-profits
Buying a put is viewed as a constructive sale, but this is a footnote in an internet article that ends with "consult your tax advior". So if you have first hand experience and have dealt with the IRS on this, I would certainly defer to that.

These are the constructive sale rules (https://www.law.cornell.edu/uscode/text/26/1259):

(c)Constructive sale For purposes of this section—
(1)In general A taxpayer shall be treated as having made a constructive sale of an appreciated financial position if the taxpayer (or a related person)—
(A)enters into a short sale of the same or substantially identical property,
(B)enters into an offsetting notional principal contract with respect to the same or substantially identical property,
(C)enters into a futures or forward contract to deliver the same or substantially identical property,
(D)in the case of an appreciated financial position that is a short sale or a contract described in subparagraph (B) or (C) with respect to any property, acquires the same or substantially identical property, or
(E)to the extent prescribed by the Secretary in regulations, enters into 1 or more other transactions (or acquires 1 or more positions) that have substantially the same effect as a transaction described in any of the preceding subparagraphs.

If you have created a constructive sale (and I am not a professional or expert tax resource), you only have a taxable event on your hands if you don't reverse the transaction on or before the 30th day after the close of the tax year... and further, you abstain from attempting anything like it again for the next 60 days thereafter.  However, at that point you've restarted the clock on the capital gains treatment again and you must hold for another 12 months for LT cap gains treatment

https://www.law.cornell.edu/uscode/text/26/1259

(3)Exception for certain closed transactions
(A)In generalIn applying this section, there shall be disregarded any transaction (which would otherwise cause a constructive sale) during the taxable year if—
(i)such transaction is closed on or before the 30th day after the close of such taxable year,
(ii)the taxpayer holds the appreciated financial position throughout the 60-day period beginning on the date such transaction is closed, and
(iii)at no time during such 60-day period is the taxpayer’s risk of loss with respect to such position reduced by reason of a circumstance which would be described in section 246(c)(4) if references to stock included references to such position.
« Last Edit: March 21, 2020, 11:10:52 PM by ERICOPOLY »

ERICOPOLY

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Re: Hedging exposure
« Reply #15 on: March 21, 2020, 11:18:52 PM »
So what's not clear to me is this following situation:

step 1). you short the stock on March 23rd, 2020 and create the constructive sale
step 2). you buy an ATM put on January 29th, 2021
step 3). you close out the short sale on January 30th, 2021

The tax code's constructive sale rules said that you had to be a good boy for the next 60 days AFTER closing out the transaction that created the constructive sale.

As far as I can tell, it did NOT say anything about how you need to behave the day beforehand.

Mephistopheles

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Re: Hedging exposure
« Reply #16 on: September 22, 2020, 06:28:55 PM »
For those who have a portfolio margin account at IBKR, what is the most you can leverage if you are hedging the entire position with puts?

thepupil

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Re: Hedging exposure
« Reply #17 on: September 22, 2020, 07:22:29 PM »
For those who have a portfolio margin account at IBKR, what is the most you can leverage if you are hedging the entire position with puts?

In my experience, more than you could or should ever reasonably want, as long as you keep the cloggers (illiquids/OTC’s) in a in a different account.

Honestly I don’t even know the formulas on equities because they always seem so low relative to the risk I want to take. Some of the bond requirements strike me as off (shorting bonds is very cumbersome margin wise)

I went 100%+ long a stock (SWY merger the day before/of close to get a free CVR), hedged with puts, and that was addition to a full portfolio.

I mean right now it says I could pull out 60% of my equity with no change to portfolio (and I don’t have much in the way of hedges on) I have no idea why they’d allow someone to run the risk that that portfolio would have
« Last Edit: September 22, 2020, 07:35:44 PM by thepupil »

bizaro86

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Re: Hedging exposure
« Reply #18 on: September 23, 2020, 09:16:54 AM »
For those who have a portfolio margin account at IBKR, what is the most you can leverage if you are hedging the entire position with puts?

Just an FYI - IB sent me an email saying they are tightening margin requirements in the run up to possible volatility around the US elections.

Gregmal

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Re: Hedging exposure
« Reply #19 on: September 23, 2020, 09:31:00 AM »
Yup, same. Probably the most substantial increase Ive seen since being there.