Tax strategy on ITM option

[benchmark]

I have some Jan 22 FB $180 option that are in the money. Selling it would mean sizable tax bill. I think FB has some additional growth to go -- my guess is that FB share would still grow at 10% going forward for the next 2-3 years, even with their meta adventure. 

 

However, exercising the option means that I'd have to use margin. Margin rate is manageable at the moment, but is this playing with fire? 

 

Are there other strategies that I'm not aware of? 

Edited November 15, 2021 by benchmark
clarification

[Gregmal]

Unless this position is greater then like 20% of the portfolio I would not worry one ounce about some margin 

[benchmark]

13 minutes ago, Gregmal said:

Unless this position is greater then like 20% of the portfolio I would not worry one ounce about some margin 

Unfortunately, it will be greater than that  

 

The other choice I have is to sell some BAC to exercise FB, I think FB has a high growth potential than BAC -- w/o the dividend though

[aws]

You could do something like turn around and longer dated calls against that to offset some of the amount on margin. But if they were ITM calls then the IRS would likely consider it a constructive sale, as anything that locks in a sizeable amount of your profit would be something the IRS is looking to tax.

[ERICOPOLY]

4 hours ago, benchmark said:

I have some Jan 22 FB $180 option that are in the money. Selling it would mean sizable tax bill. I think FB has some additional growth to go -- my guess is that FB share would still grow at 10% going forward for the next 2-3 years, even with their meta adventure. 

 

However, exercising the option means that I'd have to use margin. Margin rate is manageable at the moment, but is this playing with fire? 

 

Are there other strategies that I'm not aware of? 

 

 

 

If it were me, I would exercise and hedge your margin borrowing with a put (but only if the account is configured with 'portfolio' margin).

 

Would you not have LESS risk by doing this if you go with a higher strike put than $180?

 

You'll be borrowing $180 per share on margin, but how can you possibly lose it if you hedge out the borrowing with a put?

 

 

 

 

 

 

 

 

 

 

 

[ERICOPOLY]

Just beware of constructive sale rules if you hedge too close to the market stock price.

[benchmark]

4 hours ago, aws said:

You could do something like turn around and longer dated calls against that to offset some of the amount on margin. But if they were ITM calls then the IRS would likely consider it a constructive sale, as anything that locks in a sizeable amount of your profit would be something the IRS is looking to tax.

 

Can you expand on this? Are you saying that I if exercise at $180, then turn around and sell some long dated calls say $350 in Jan 24, IRS would somehow tax me? Are they taxing me because I exercised the option w/o paying taxes or are they taxing me on the long dated calls?

Edited November 16, 2021 by benchmark
typo

[benchmark]

1 hour ago, ERICOPOLY said:

 

 

 

If it were me, I would exercise and hedge your margin borrowing with a put (but only if the account is configured with 'portfolio' margin).

 

Would you not have LESS risk by doing this if you go with a higher strike put than $180?

 

You'll be borrowing $180 per share on margin, but how can you possibly lose it if you hedge out the borrowing with a put?

 

 

 

 

 

 

 

 

 

 

 

If I understand you correctly. You are saying that exercise at $180, the buy some puts say Jan 24 $380 to hedge the potential drop of FB shares?  I don't know much about 'portfolio' margin. The key difference seems to be that long options are marginable, but I don't know why this is required to execute the strategy? 

[ERICOPOLY]

1 hour ago, benchmark said:

If I understand you correctly. You are saying that exercise at $180, the buy some puts say Jan 24 $380 to hedge the potential drop of FB shares?  I don't know much about 'portfolio' margin. The key difference seems to be that long options are marginable, but I don't know why this is required to execute the strategy? 

 

Don't purchase the $380 puts because you're creating a constructive sale.  You wrote $380... maybe you meant $180?  

 

Portfolio margin works differently than Reg-T margin in that you are given credit for the fact that the puts hedge away your risk.  Reg-T does not do that.  You can get margin called in situations under Reg-T that could not possibly get you a margin call if your account were configured for portfolio margin.

 

 

 

Edited November 16, 2021 by ERICOPOLY

[ERICOPOLY]

Munger's stories about Rick Guerin and margin call risk became dated after portfolio margin became possible.  Now you can use puts and margin and create something akin to non-recourse margin borrowing.

Edited November 16, 2021 by ERICOPOLY

[ERICOPOLY]

I just bought ATCO shares this week paired with $10 strike May puts for 30 cents in my portfolio margin account.

 

I'd like Munger to explain how much money I can lose if the share temporarily dip down by 99%.

 

[LC]

5 minutes ago, ERICOPOLY said:

I just bought ATCO shares this week paired with $10 strike May puts for 30 cents in my portfolio margin account.

 

I'd like Munger to explain how much money I can lose if the share temporarily dip down by 99%.

 

Assume you got better pricing this way than just buying call options? And no dividend drag either. 

[ERICOPOLY]

8 minutes ago, LC said:

Assume you got better pricing this way than just buying call options? And no dividend drag either. 

 

 

In a taxable account I don't like going with calls because once you exercise them you're back to a short term holding again and must wait yet another 12 months for long term status.

 

 

 

[ERICOPOLY]

Also, eventually I'm going to wind up on margin with the puts after exercising the calls.  So why not just start out that way to begin with?

[benchmark]

23 minutes ago, ERICOPOLY said:

 

Don't purchase the $380 puts because you're creating a constructive sale.  You wrote $380... maybe you meant $180?  

 

Portfolio margin works differently than Reg-T margin in that you are given credit for the fact that the puts hedge away your risk.  Reg-T does not do that.  You can get margin called in situations under Reg-T that could not possibly get you a margin call if your account were configured for portfolio margin.

 

 

 

does buy $180 put implies that a non-constructive sale? I actually have various strikes, does that mean that I have to buy puts at the various strikes so that it's not constructive sale? 

 

If I do this, then my carrying cost  is the margin cost + the cost of the puts, is that right? As long as FB appreciating faster (assumption), I'm in the green -- do I get this right? 

[ERICOPOLY]

27 minutes ago, benchmark said:

does buy $180 put implies that a non-constructive sale? I actually have various strikes, does that mean that I have to buy puts at the various strikes so that it's not constructive sale? 

 

If I do this, then my carrying cost  is the margin cost + the cost of the puts, is that right? As long as FB appreciating faster (assumption), I'm in the green -- do I get this right? 

 

Care needs to be taken to assure that investors maintain at least a 15% band, even if that requires an out-of-pocket expenditure.

 

https://www.nysscpa.org/news/publications/the-trusted-professional/article/tools-techniques-to-shield-and-defer-taxes-on-unrealized-stock-gains

 

 

FB right now trades at $348.  So I figure if you buy a put far below this level... like under $270 strike... then that should be well clear of this "15% band" that is recommended in the article above.  The IRS apparently doesn't want you to be able to use a put to lock in all of your gains without leaving some of your skin in the game, so they'll rule it a constructive sale if you hedge with at-the-money puts.

 

So I believe you can use a put strike somewhere considerably higher than $180 without running afoul of what is recommended in that article.

 

 

 

Edited November 16, 2021 by ERICOPOLY

[LC]

26 minutes ago, ERICOPOLY said:

Also, eventually I'm going to wind up on margin with the puts after exercising the calls.  So why not just start out that way to begin with?

Makes sense

 

Assuming the underlying trade thesis, this may be an interesting read: 

https://medium.com/@ryan79z28/im-a-twenty-year-truck-driver-i-will-tell-you-why-america-s-shipping-crisis-will-not-end-bbe0ebac6a91

 

 

[LC]

A different take (slightly) 

https://www.bridgewater.com/its-mostly-a-demand-shock-not-a-supply-shock-and-its-everywhere

[ERICOPOLY]

19 minutes ago, benchmark said:

If I do this, then my carrying cost  is the margin cost + the cost of the puts, is that right? As long as FB appreciating faster (assumption), I'm in the green -- do I get this right? 

 

 

So, for example, I paid 30 cents for my ATCO $10 strike puts.  Annualized, that will cost 72 cents or 7.2% of the $10 that I am borrowing on margin.  Now, if my margin interest rate is 1% then my annualized borrowing cost is about 8.2%.

 

Keep in mind that is non-recourse leverage.

 

Sure, I borrowed non-recourse at 2.8% against my home... but my home won't compound in value like ATCO will.  So I think the logic speaks for itself.

[benchmark]

6 minutes ago, ERICOPOLY said:

 

 

So, for example, I paid 30 cents for my ATCO $10 strike puts.  Annualized, that will cost 72 cents or 7.2% of the $10 that I am borrowing on margin.  Now, if my margin interest rate is 1% then my annualized borrowing cost is about 8.2%.

 

Keep in mind that is non-recourse leverage.

 

Sure, I borrowed non-recourse at 2.8% against my home... but my home won't compound in value like ATCO will.  So I think the logic speaks for itself.

I think I get it, the carrying cost is the margin cost + put cost annualized. One question, if you think ATCO is going to double, why not buy a long dated put option to get some long term protection? 

[ERICOPOLY]

4 minutes ago, benchmark said:

I think I get it, the carrying cost is the margin cost + put cost annualized. One question, if you think ATCO is going to double, why not buy a long dated put option to get some long term protection? 

 

I bought the May put because it is only 30 cents. 

 

It expires on May 20, 2022 and suppose the stock trades at $18 on expiration day.  Will it still cost 30 cents for another 5 months of put protection?  Hell no!  It might be only 5 cents or 10 cents.

 

Why?  Skewness.  The further away from the strike price you go, the cheaper the put will be.

 

But if the stock is at $10 next May, well, I'll pay a lot more than 30 cents for the next 5 months.

 

So that's the tradeoff.  Instead of locking in the put at a certain price until January 2024, I am betting that the stock will rise and I'll be able to lock in the longer dated put for a much lower premium in the future.

 

 

[ERICOPOLY]

So back to the house analogy where the mortgage is 2.8% annualized...

 

The put will virtually cost me nothing once ATCO is trading in excess of $20 per share.  Far out of the money puts are practically given away.

 

So the non-recourse loan will only be expensive while the share trades close to the $10 strike.  In later years, this leverage is all gravy (unless interest rates rise a lot).

[benchmark]

5 minutes ago, ERICOPOLY said:

 

I bought the May put because it is only 30 cents. 

 

It expires on May 20, 2022 and suppose the stock trades at $18 on expiration day.  Will it still cost 30 cents for another 5 months of put protection?  Hell no!  It might be only 5 cents or 10 cents.

 

Why?  Skewness.  The further away from the strike price you go, the cheaper the put will be.

 

But if the stock is at $10 next May, well, I'll pay a lot more than 30 cents for the next 5 months.

 

So that's the tradeoff.  Instead of locking in the put at a certain price until January 2024, I am betting that the stock will rise and I'll be able to lock in the longer dated put for a much lower premium in the future.

 

 

Got it. And the reason that you chose $10 put vs $12.5 is mostly just a consideration on how expensive the put is I assume,  30c vs 80c? 

 

If the stock does go down to below $10 by May 22, then you total loss is $14.5 - $10 + margin cost + put cost. 

[ERICOPOLY]

7 minutes ago, benchmark said:

Got it. And the reason that you chose $10 put vs $12.5 is mostly just a consideration on how expensive the put is I assume,  30c vs 80c? 

 

If the stock does go down to below $10 by May 22, then you total loss is $14.5 - $10 + margin cost + put cost. 

 

Yes, I'm adding an extra $2.50 of risk in return for a cheaper put.  

 

Yes, the risk profile is basically the same as buying a $10 strike call.

[ERICOPOLY]

In my Roth IRA the best I've done is paying a 90 cent premium for the 2024 $10 strike call. 

 

That works out to roughly 8.5% annualized cost after accounting for the annual 50 cent dividend.

 

So the May 30 cent put is competitive with that, but will be far cheaper if the shares rise considerably before May.