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There are times when you accrue stock positions in a company. This can be a problem in terms of diversification, liquidity, and taxes. When you’re highly concentrated on a Profitix Broker stock position, you expose yourself to significant risk. To resolve this matter, you can use the following methods. Read on.
Using Equity Collars
The first way is a very popular hedging method and you might even be familiar with this one. In the equity collar method, you purchase a long-dated put option on the concentrated stock holding combined with the sale of a long-dated call option.
The collar should leave enough room for potential gains and losses so that it is not construed as a constructive sale by the IRS and be taxed.
The put option provides you the right to sell your non-diversified stock position at a given price in the future, offering them with some Profitix Trading Platform downside protection. The sale of the call option offers you some premium income that you can use to pay for the purchase of the put option.
Usually, many will choose a “costless” collar, in which the premium for the sale is just enough to cover the whole cost of the purchasing the put option, leading to a zero cash outflow on your part.
Using the Variable Prepaid Forward Method
Another common strategy that can achieve a similar effect is the technique of using a variable prepaid forward contract.
In this transaction, you will agree to sell your shares at a future date in exchange for a cash advance at the present.
The number of shares that can be sold in the future will change depending on performance of the stock in the market. Higher stock prices mean fewer shares will be sold in order to satisfy the obligation, and the opposite is true for lower stock prices. This variability is among the many reason why the IRS does not consider VPF as a constructive sale.
You can get immediate liquidity from the cash advance. Also, it lets for some deferral of capital gains and flexibility when it comes to choosing the future sale date of the stock.
Pooling Shares into an Exchange Fund
The first two methods we have discussed use over-the-counter derivatives that try to reduce the downside risk. Meanwhile, this method will do that too—plus it will leave more room for more upside.
This method lets you benefit from the fact that there are a number of investors just like you with a concentrated stock position. Basically, you will pool your shares into a partnership and each of you will receive a pro-rata share of the exchange fund.
You will own a share of a fund that has a portfolio of different stocks, meaning this also allows for some amount of diversification. You can also benefit from deferral of taxes.
Rebalancing with Completion Fund
This is an essentially straightforward approach. A completion fund diversifies a single position by selling small portions of the holding slowly over time. Then, it reinvests the money to buy a more diversified portfolio.
In comparison with the exchange fund method, you will still be in control of your assets. You can also complete your desired diversification within a specific period of time.
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