Thinking through some hedging

[rayfinkle]

Hi all! I recently made a large amount of gains in a highly volatile stock and want to liquidate. My accountant and I have determined that most of the taxes won’t require periodic or pre payments. So I’ll have a meaningful tax bill floating for about six months and am considering how to earn income on it. Has anyone thought this problem through?

 

For example, I’m considering buying a selection of well managed yield manufacturers (eg NLY if I can get comfortable with their performance with rising rates) and then hedge out the general market (eg spy put call spread). But would appreciate thoughts from the group.

 

Thanks!

[bizaro86]

Hi all! I recently made a large amount of gains in a highly volatile stock and want to liquidate. My accountant and I have determined that most of the taxes won’t require periodic or pre payments. So I’ll have a meaningful tax bill floating for about six months and am considering how to earn income on it. Has anyone thought this problem through?

 

For example, I’m considering buying a selection of well managed yield manufacturers (eg NLY if I can get comfortable with their performance with rising rates) and then hedge out the general market (eg spy put call spread). But would appreciate thoughts from the group.

 

Thanks!

 

For money I needed to pay taxes with, I'd use a high interest savings account, or T-bills.

[cwericb]

"For money I needed to pay taxes with, I'd use a high interest savings account, or T-bills."

 

Ditto !!

 

I had an acquaintance who had a large capital gain on an apartment building they sold in the late Spring of 2008. The DOW had recently taken a dip back to about 13,000 and looked like it was gaining upward momentum again.

 

Since the tax wasn’t due until April of 2009, the money was invested into some relatively ‘secure’ companies paying decent dividends.

 

By tax time the DOW had bottomed in the 6,500 range and more than half the tax money had vanished.

 

 

[Dynamic]

I think the advice to minimize the risk of it being worth any less by the time it must be paid is very sound.

 

Think of it as being short-term float: borrowed money that certainly belongs to someone other than yourself (the IRS, assuming you're in the USA) which you are very firmly obliged to pay back, but you are allowed to do with it as you wish for a few months, providing you pay back the principal. Earning a safe 1% or so on a large chunk of someone else's money you've been lent for 6 months is a bonus you wouldn't have if you'd had the tax withheld on sale, so treat that as a cash bonus and play it safe.

 

When you have a fixed amount to pay on a fixed date much less than 3-5 years away, you must both ensure that you don't lose your principal and get the timing right too. With stock investing, there are many times that an investment works out in the end, but for a year or two after buying, the market price is showing a paltry return or a substantial loss, and that's where having time on your side stops you having to sell far below Intrinsic Value because you are committed to sell your position at a specific date. You can be right about the outcome but if you're wrong about the timing, it can very costly.

 

If you enter into any positions where timing is critical, you have to think very carefully about the risks you're taking including whether your downside is capped, so you cannot wipe yourself out, and whether the potential reward significantly outweighs the risk. If you need to hedge, you'll pay a significant cost to do so, this may well be outside your circle of competence, and you'll have a lot more stress hoping you are as adequately 'insured' as you intended.

 

Only invest with 'borrowed money' like this if you'd do the same by borrowing the same amount on margin.

[rayfinkle]

Thanks all... much appreciated. This is largely how I'm thinking about it. A flavor on this is just make sure I have appropriate "reserves" that's the key