. Planning for Executives - 7 Value, risks, and tax implications of utilizing cashless collars in concentrated stock situations Flashcards
What is a cashless collar?
A costless, or zero cost, zoro-premium collar is an options spread involving the purchase of a protective put on an existing stock position, funded by the sale of an out of the money call. Zero cost collars can be established to fully protect existing long stock positions with little or no cost.
Depict a concentrated stock situation?
A concentrated stock position is when an investor holds more than 10% of their portfolio in a single name. While diversification remains a mantra in the investment industry for its ability to reduce volatility and potentially boost returns, the reality is that many investors do have a lot of eggs in only one basket.
What are the purposes of a cashless collar?
Hedging:
Investor wants to reduce downside in position while
deferring capital gain recognition
* Purchases put option below current market price and
simultaneously sells call option above current market
price against holdings for net zero premium
* Contract allows investor to specify option maturities and
degree of upside/downside exposure
31
Depict some advantages of cashless collars?
Hedges downside risk below put strike price
* Retains ownership benefits of dividend income
and voting rights
* Avoids immediate capital gain recognition
Depict some disadvantages of cashless collars?
Interim price risk
* Limited upside price participation
* Collateral requirements for payment due at
maturity
* Potential for capital gains taxes on underlying
stock position upon exercise
* “Hard to borrow” risk – Amount borrowed
depends on strategy, size of client’s hedged
position and may limit size of transaction
* Market liquidity – Brokerage firm may need to
trade in underlying security to manage market
risk; based on trading volume in underlying
security
32
Depict some tax implications of cashless collars?
Depending on the term length of the option, any gains may be taxed at your ordinary income rate rather than long-term capital gain rate. The zero-cost collar strategy above “pays off” if the market falls more than 10%, but the marginal benefit of this payoff decreases as taxes must paid on the gains of the put option
The taxability of this option contribution differs, based on the underlying components and their tenure, and must be analyzed as part of the larger strategy in advance.
Hedging incentive stock options before or shortly after exercise creates a separate and special set of considerations, since hedging during the first year after exercise might be a disqualifying disposition and trigger ordinary income taxes.
In addition to general taxability, special tax rules might apply, as some transactions could be considered a “constructive sale.” Consider seeking the advice of a tax professional before beginning an options-based disposition strategy.
Another name for cashless collars are ____________?
Zero premium collars
Explain the desired outcome for cashless collars
Protects long stock positions
Is collar strategy bullish or bearish?
Protective collars are considered a bearish-to-neutral strategy. The loss in a protective collar is limited, but so is the potential upside. An equity collar is created by selling an equal number of call options and buying the same number of put options on a long stock position.
