customized derivatives -- full service brokers

[ERICOPOLY]

Alright... I know next to nothing about this but I have a hopeful imagination.

 

Which door do I knock on to find a counterparty willing to purchase from me a long term deep-in-the-money put contract.

 

For example, if I can write a 5 year put option on WFC with something like a $200 strike, the value of that put would carry a premium that compensates me for a reasonable approximation of the dividends that WFC will pay over the next 5 years.

 

When assigned after 5 years, I get the shares and still no tax bill due yet. 

 

Instead, I could just purchase the common stock but California is not the kind of place where you want to earn taxable dividends (better to get them as deferred capital gains).

 

The details aren't clear, but the gist of it is that I would want a super high strike price to ensure I don't get taxed on a put option expiring out of the money (I want to be nearly certain of being assigned the shares).

 

Maybe somebody who has a lot of tax assets to use up in the US would be interested (because they'll be paying the taxes instead of me).  Citigroup?  Or perhaps an insurance company who only gets taxed at 14.5% rate on dividends.

 

Effectively, I want to pay them a small fee for the right to use their lower tax rate.  Surely there is room for us both to come out ahead.

 

Or perhaps just a Bermuda company where they carry no tax burden.

[Kraven]

Alright... I know next to nothing about this but I have a hopeful imagination.

 

Which door do I knock on to find a counterparty willing to purchase from me a long term deep-in-the-money put contract.

 

For example, if I can write a 5 year put option on WFC with something like a $200 strike, the value of that put would carry a premium that compensates me for a reasonable approximation of the dividends that WFC will pay over the next 5 years.

 

When assigned after 5 years, I get the shares and still no tax bill due yet. 

 

Instead, I could just purchase the common stock but California is not the kind of place where you want to earn taxable dividends (better to get them as deferred capital gains).

 

The details aren't clear, but the gist of it is that I would want a super high strike price to ensure I don't get taxed on a put option expiring out of the money (I want to be nearly certain of being assigned the shares).

 

Maybe somebody who has a lot of tax assets to use up in the US would be interested (because they'll be paying the taxes instead of me).  Citigroup?  Or perhaps an insurance company who only gets taxed at 14.5% rate on dividends.

 

Effectively, I want to pay them a small fee for the right to use their lower tax rate.  Surely there is room for us both to come out ahead.

 

Or perhaps just a Bermuda company where they carry no tax burden.

 

Which brokerage do you use?  If you have an account with one that has an investment bank just ask your rep to put you in touch with the equity derivatives desk. You might be able to get someone interested. Most though wont want to face an individual (too much risk including suitability, etc) but for the right price they might go forward. Its worth exploring.

[ERICOPOLY]

I use IB.

 

Given that I have no experience ever talking with the professionals, I have no idea how this is done.  But given the trillions in derivatives out there, I feel like the patsy paying the tax and want to get with the program.

 

[Kraven]

I use IB.

 

Given that I have no experience ever talking with the professionals, I have no idea how this is done.  But given the trillions in derivatives out there, I feel like the patsy paying the tax and want to get with the program.

 

I think what I would do in your shoes is contact customer relations at a couple full service brokerages like Morgan Stanley, Merrill, JPM, etc - something like that where there is an investment bank too. Get yourself to a rep who handles high net worth people. Tell them that you are considering moving some or all of your sizable account but first want to speak to someone on their equity derivatives desk about a potential trade. Tell them that in order to move the account it will take being able to successfully consummate the trade (they will try to pressure the desk which won't really work but is better than nothing). They will hook you up with someone.

 

Personally, I think it will be tough for you to get this done for many reasons but that doesn't mean it isn't worth trying. You can probably have your conversations and know whether this might be possible in a day or 2. Good luck.

[onyx1]

Eric, even with your quickly growing assets most brokers will consider you a retail customer.  And with retail, the suitability risk (even with a QIB letter) for any derivative trade is considered large as brokers are made parties to claims all the time.  Using the "widows and orphans" defense the retail customers frequently win when in front of an arbitrator. 

 

You need to have a very good relationship with a broker (I believe Twacowcfa falls into this category and often executes non-recourse derivative trades), or you need to have a prime broker who will guarantee trades on your behalf and give you access to a variety of financing, credit, securities, and derivatives offerings unavailable to retail. 

[ERICOPOLY]

Thanks for the color regarding the treatment of retail investors.

 

What is the cheapest/easiest route to mature into an "institutional" client versus a "retail" client?  What kind of a legal entity will they do such business with?  Were I to set up an investment partnership, LLC similar to what Sanjeev runs, would that suffice?  Even if I'm the only investor in the fund?

 

I'd rather pay the lawyers and accountants than the tax collectors.

[twacowfca]

Eric, even with your quickly growing assets most brokers will consider you a retail customer.  And with retail, the suitability risk (even with a QIB letter) for any derivative trade is considered large as brokers are made parties to claims all the time.  Using the "widows and orphans" defense the retail customers frequently win when in front of an arbitrator. 

 

You need to have a very good relationship with a broker (I believe Twacowcfa falls into this category and often executes non-recourse derivative trades), or you need to have a prime broker who will guarantee trades on your behalf and give you access to a variety of financing, credit, securities, and derivatives offerings unavailable to retail.

 

You will probably need to show that you are a "sophisticated investor", not merely a "qualified investor " to be able to execute derivative trades with a major investment bank.  I had to meet with a panel from that bank and show them that I had a very long history of executing derivative trades and that I  knew things about derivatives that many of them did not know before I was allowed to join that club.

 

I explained the rationale for a large trade (for me) that I wanted to make. They thought what I was wanting to do was risky at first, but then they came to understand that I was actually reducing risk by taking money off the table while increasing notional exposure. 

 

All the trades have worked out extremely well for me and not unprofitably for my counterpart because those trades were merely part of their delta hedging.  Be aware that once you are a member of that club, you will have to hold your own against those who know every sharp angle.

 

May I suggest instead that you simply start to deal with the family office of a major brokerage and let them purchase the derivative for you.  That might actually be the better way as my first experience trading with the bank was unpleasant because their traders seemed to view me through the same lens  as the car salesman uses to size up the proverbial dippy blonde who wants to buy a car.  :)

 

Wherever you go, shop around.  I haven't been pleased with the negotiated price quotes I've gotten through my broker and have gotten better deals negotiating directly with the TBTF bank, once their traders realized I could hold my own with them.

[ERICOPOLY]

Thanks for the helpful comments!

[berkshiremystery]

Eric,...

 

You might want to lurk into Jim Simons tax strategies.

 

-----

 

Simons Strategy to Shield Profit From Taxes Draws IRS Ire

http://www.bloomberg.com/news/2013-07-01/simons-strategy-to-shield-profit-from-taxes-draws-irs-ire.html

 

http://jewishbusinessnews.com/2013/07/07/james-simons-and-renaissance-in-tax-dispute-with-the-irs/

 

The Basket Option

 

Renaissance’s strategy involves buying a derivative instrument called a “basket option contract,” from a number of banks. As described in the IRS memo and by people with knowledge of the matter, the transaction worked as follows:

 

i) A bank buys a portfolio of stocks and other instruments that fund managers at Renaissance wanted to trade. The bank hired the fund managers to oversee the portfolio, paying them a nominal fee.

ii) Then Medallion bought an option with a term of two years, whose value was linked to the worth of the portfolio. Renaissance had full discretion to trade the securities in the portfolio.

iii) Medallion could claim it owned just one asset — the option -which it held for more than a year, allowing any gain to be treated as “long-term” when its investors reported the income on their personal tax returns.

 

 

[kmukul]

Thanks for the color regarding the treatment of retail investors.

 

What is the cheapest/easiest route to mature into an "institutional" client versus a "retail" client?  What kind of a legal entity will they do such business with?  Were I to set up an investment partnership, LLC similar to what Sanjeev runs, would that suffice?  Even if I'm the only investor in the fund?

 

I'd rather pay the lawyers and accountants than the tax collectors.

 

Hi Eric,

I know you are a lot smarter than me but still I think this may work, it may not work also you need to check. What if you create a LLC or hedgefund based in some other state or country and have your money loaned to it.it pays tax in that state or country for trades done and pays you in cash and kind (like buying cars which are leased to you). I don't know what will require to make it legal. if it doesn't work,  hope its still ok to post,

 

By the way is this your portfolio? https://www.tickerspy.com/member.php?mid=74868&pid=105574

 

 

[twacowfca]

Thanks for the color regarding the treatment of retail investors.

 

What is the cheapest/easiest route to mature into an "institutional" client versus a "retail" client?  What kind of a legal entity will they do such business with?  Were I to set up an investment partnership, LLC similar to what Sanjeev runs, would that suffice?  Even if I'm the only investor in the fund?

 

I'd rather pay the lawyers and accountants than the tax collectors.

 

Hi Eric,

I know you are a lot smarter than me but still I think this may work, it may not work also you need to check. What if you create a LLC or hedgefund based in some other state or country and have your money loaned to it.it pays tax in that state or country for trades done and pays you in cash and kind (like buying cars which are leased to you). I don't know what will require to make it legal. if it doesn't work,  hope its still ok to post,

 

By the way is this your portfolio? https://www.tickerspy.com/member.php?mid=74868&pid=105574

 

I don't think what you are describing would qualify under IRS regulations.

[twacowfca]

Eric,...

 

You might want to lurk into Jim Simons tax strategies.

 

-----

 

Simons Strategy to Shield Profit From Taxes Draws IRS Ire

http://www.bloomberg.com/news/2013-07-01/simons-strategy-to-shield-profit-from-taxes-draws-irs-ire.html

 

http://jewishbusinessnews.com/2013/07/07/james-simons-and-renaissance-in-tax-dispute-with-the-irs/

 

The Basket Option

 

Renaissance’s strategy involves buying a derivative instrument called a “basket option contract,” from a number of banks. As described in the IRS memo and by people with knowledge of the matter, the transaction worked as follows:

 

i) A bank buys a portfolio of stocks and other instruments that fund managers at Renaissance wanted to trade. The bank hired the fund managers to oversee the portfolio, paying them a nominal fee.

ii) Then Medallion bought an option with a term of two years, whose value was linked to the worth of the portfolio. Renaissance had full discretion to trade the securities in the portfolio.

iii) Medallion could claim it owned just one asset — the option -which it held for more than a year, allowing any gain to be treated as “long-term” when its investors reported the income on their personal tax returns.

 

This looks beyond edgy, more like over the top.  It's something set up merely to dodge taxes, and they had control over the operations.

[nnayyar]

If your account is large enough, you may be able to switch to an 'institutional' or prime account at IB. That way you can do a 'doneaway' transaction with any outside broker you choose (JP, GS, or the many many other small Broker Dealers) The BD would likely need a minimum size but I can't see why they wouldn't be able to price a 5 year deep iTM put option for you? They would execute and the trade is basically ACAT over to your account. Just an idea.

 

 

[AtlCDore]

"For example, if I can write a 5 year put option on WFC with something like a $200 strike, the value of that put would carry a premium that compensates me for a reasonable approximation of the dividends that WFC will pay over the next 5 years.

 

When assigned after 5 years, I get the shares and still no tax bill due yet."

 

Eric,

 

There is a good chance you may pay a premium to buy a deep in the money put 5 years out.  But more importantly, you should verify with your accountant that buying a deep-in-the-money put will not trigger the IRS into thinking that you "sold" the stock.

 

Best,

 

AtlCDore

[ERICOPOLY]

"For example, if I can write a 5 year put option on WFC with something like a $200 strike, the value of that put would carry a premium that compensates me for a reasonable approximation of the dividends that WFC will pay over the next 5 years.

 

When assigned after 5 years, I get the shares and still no tax bill due yet."

 

Eric,

 

There is a good chance you may pay a premium to buy a deep in the money put 5 years out.  But more importantly, you should verify with your accountant that buying a deep-in-the-money put will not trigger the IRS into thinking that you "sold" the stock.

 

Best,

 

AtlCDore

 

I don't want to buy the put.  I want to write it.

[LC]

Didn't Warren write long term puts on the S&P? We should rename you "Uncle Eric" :D

[AtlCDore]

My Bad.  I'm off to an inauspicious start.

[berkshiremystery]

"For example, if I can write a 5 year put option on WFC with something like a $200 strike, the value of that put would carry a premium that compensates me for a reasonable approximation of the dividends that WFC will pay over the next 5 years.

 

When assigned after 5 years, I get the shares and still no tax bill due yet."

 

Eric,

 

There is a good chance you may pay a premium to buy a deep in the money put 5 years out.  But more importantly, you should verify with your accountant that buying a deep-in-the-money put will not trigger the IRS into thinking that you "sold" the stock.

 

Best,

 

AtlCDore

 

I don't want to buy the put.  I want to write it.

 

Eric,...

 

You should have a close look at Charles Ledley and James Mai in the book "The Big Short". They were in a similar position like you. They started from a garage in Berkley, CA with capital of only $110k in a Schwab account. These two guys were able get a license from Deutsche Bank's KYC program (Know Your Customer program) to trade directly with the most sophisticated, quantitative trading desks with the big boys on Wall Street, but by then they were able to manage already some $30M AUM. The hunting license, they called it. The hunting license had a name: an "ISDA", and was dreamed up by the International Swaps and Derivatives Association. Usually you are only allowed to trade with the big boys if you have something like $2B AUM,... so they got really cheap into the system.

 

So the only available workaround might be to start your own partnership and some people that might help you raise $30M.

 

http://en.wikipedia.org/wiki/Cornwall_Capital

 

http://www.cornwallcapital.com/

 

 

 

 

 

 

[Kraven]

"For example, if I can write a 5 year put option on WFC with something like a $200 strike, the value of that put would carry a premium that compensates me for a reasonable approximation of the dividends that WFC will pay over the next 5 years.

 

When assigned after 5 years, I get the shares and still no tax bill due yet."

 

Eric,

 

There is a good chance you may pay a premium to buy a deep in the money put 5 years out.  But more importantly, you should verify with your accountant that buying a deep-in-the-money put will not trigger the IRS into thinking that you "sold" the stock.

 

Best,

 

AtlCDore

 

I don't want to buy the put.  I want to write it.

 

Eric,...

 

You should have a close look at Charles Ledley and James Mai in the book "The Big Short". They were in a similar position like you. They started from a garage in Berkley, CA with capital of only $110k in a Schwab account. These two guys were able get a license from Deutsche Bank's KYC program (Know Your Customer program) to trade directly with the most sophisticated, quantitative trading desks with the big boys on Wall Street, but by then they were able to manage already some $30M AUM. The hunting license, they called it. The hunting license had a name: an "ISDA", and was dreamed up by the International Swaps and Derivatives Association. Usually you are only allowed to trade with the big boys if you have something like $2B AUM,... so they got really cheap into the system.

 

So the only available workaround might be to start your own partnership and some people that might help you raise $30M.

 

http://en.wikipedia.org/wiki/Cornwall_Capital

 

http://www.cornwallcapital.com/

 

There is a chapter in Hedge Fund Wizards about Jamie Mai. It's very interesting. It would seem that Michael Lewis took some artistic license in the telling of the Cornwall Capital story. Ledley and Mai were made to seem like a couple of down on their luck "losers" who somehow strike it big. On the contrary, Mai's father ran AEA Investors, a multi billion dollar PE firm. They were in the process of setting up a family office for Mai to run. So while it is technically true they started with a Schwab account, it was because it was taking some time to get things going and they wanted to get started. There was apparently a lot of money backing them. In addition, they are portrayed as not knowing much about the markets, etc while the truth is they both started at Golub I think it was. Still an interesting story but much less impressive than it was made to seem. They were much savvier than they were given credit for with tons of connections in the market.

[berkshiremystery]

"For example, if I can write a 5 year put option on WFC with something like a $200 strike, the value of that put would carry a premium that compensates me for a reasonable approximation of the dividends that WFC will pay over the next 5 years.

 

When assigned after 5 years, I get the shares and still no tax bill due yet."

 

Eric,

 

There is a good chance you may pay a premium to buy a deep in the money put 5 years out.  But more importantly, you should verify with your accountant that buying a deep-in-the-money put will not trigger the IRS into thinking that you "sold" the stock.

 

Best,

 

AtlCDore

 

I don't want to buy the put.  I want to write it.

 

Eric,...

 

You should have a close look at Charles Ledley and James Mai in the book "The Big Short". They were in a similar position like you. They started from a garage in Berkley, CA with capital of only $110k in a Schwab account. These two guys were able get a license from Deutsche Bank's KYC program (Know Your Customer program) to trade directly with the most sophisticated, quantitative trading desks with the big boys on Wall Street, but by then they were able to manage already some $30M AUM. The hunting license, they called it. The hunting license had a name: an "ISDA", and was dreamed up by the International Swaps and Derivatives Association. Usually you are only allowed to trade with the big boys if you have something like $2B AUM,... so they got really cheap into the system.

 

So the only available workaround might be to start your own partnership and some people that might help you raise $30M.

 

http://en.wikipedia.org/wiki/Cornwall_Capital

 

http://www.cornwallcapital.com/

 

There is a chapter in Hedge Fund Wizards about Jamie Mai. It's very interesting. It would seem that Michael Lewis took some artistic license in the telling of the Cornwall Capital story. Ledley and Mai were made to seem like a couple of down on their luck "losers" who somehow strike it big. On the contrary, Mai's father ran AEA Investors, a multi billion dollar PE firm. They were in the process of setting up a family office for Mai to run. So while it is technically true they started with a Schwab account, it was because it was taking some time to get things going and they wanted to get started. There was apparently a lot of money backing them. In addition, they are portrayed as not knowing much about the markets, etc while the truth is they both started at Golub I think it was. Still an interesting story but much less impressive than it was made to seem. They were much savvier than they were given credit for with tons of connections in the market.

 

Kraven,...

 

thanks for pointing this out.