Protecting The Value of Stock Options

[FIREd]

DW's company stock has done very well YTD and her stock options are now worth a few hundred thousand dollars. We can't exercise the options and sell the stock at the moment because the trading window is closed. All the talk about a potential market crash has me worried. Because of the leveraged nature of stock options, a decline of 50% in her company stock price would basically render her options worthless. Is there a way to hedge against a potential market decline until the trading window re-opens? I was thinking about using a leveraged inverse ETF like SDS but it seems like these ETF present potential issues when held for periods of time longer than a day it two. Any other ideas?

 

[pb4uski]

Just wondering if you could sell an option with the same/similar terms to the option DW holds which would in effect monetize the options that she holds and insulate you from any downside (and upside) in the company stock. Subsequently you would unwind/settle both positions at the same time and the change in value from today on the long side (DW's option) would offset the change in value on the hedge.

 

[growing_older]

If you buy a put at current levels (or slightly below if you want to reduce the premium you pay) then if the stock continues to rise you let the thing expire worthless. If the price drops, you exercise the company options at the new lower price and then "put" them to your counterparty at the price you agreed. For the premium paid you have established the current price (or nearly) as a base.

Be careful, some companies regard trading in options as forbidden during lockup windows. You'll probably want to be sure you understand what the rules are.

 

[FIREd]

Just wondering if you could sell an option with the same/similar terms to the option DW holds which would in effect monetize the options that she holds and insulate you from any downside (and upside) in the company stock. Subsequently you would unwind/settle both positions at the same time and the change in value from today on the long side (DW's option) would offset the change in value on the hedge.

It would be ideal but employees are forbidden to trade company stock or derivatives of that stock while the trading window is closed.

 

[brewer12345]

You could buy a put on either the whole market or on a sector etf that tracks your dw's employer's industry. But this would come at a cost and there would be significant basis risk.

Can I ask where you bought your crystal ball?

 

[pb4uski]

It would be ideal but employees are forbidden to trade company stock or derivatives of that stock while the trading window is closed.

I assume that employees also means spouses.

Is there a competitor company that moves similarly to DW's employer's stock that you could use as a proxy? Still would be breakage risk but it might be better than doing nothing.

Have you talked with your broker on potential strategies?

 

[FIREd]

You could buy a put on either the whole market or on a sector etf that tracks your dw's employer's industry. But this would come at a cost and there would be significant basis risk.

Can I ask where you bought your crystal ball?

I bought it on Amazon. 100% accuracy guaranteed.

Seriously though, I don't know where the market is going. However, I have enough experience with managing DW's stock options to know what leverage can do both to the upside and to the downside. We have had one hell of a ride for the past 8 years (from zero to almost seven figures to zero again to where we are now). With that in mind, now that her options are worth a decent amount again, I want to find a cheap way to limit the downside, just in case. With a leveraged inverse ETF, the downside is limited to what I invest but the upside is not. That's the kind of strategies I am looking for.

 

[FIREd]

I assume that employees also means spouses.

Correct.

Is there a competitor company that moves similarly to DW's employer's stock that you could use as a proxy? Still would be breakage risk but it might be better than doing nothing.

The stock *generally* moves in sync with its specific sector.

Have you talked with your broker on potential strategies?

I don't have a broker. I want to keep it simple. And cheap.

 

[MooreBonds]

DW's company stock has done very well YTD and her stock options are now worth a few hundred thousand dollars. We can't exercise the options and sell the stock at the moment because the trading window is closed. All the talk about a potential market crash has me worried. Because of the leveraged nature of stock options, a decline of 50% in her company stock price would basically render her options worthless. Is there a way to hedge against a potential market decline until the trading window re-opens? I was thinking about using a leveraged inverse ETF like SDS but it seems like these ETF present potential issues when held for periods of time longer than a day it two. Any other ideas?

Not trying to split hairs...but are the prohibitions specifically on your wife for trading a derivative? Or does it include their spouse? What about her parent, or your parent? A child? Also, could the prohibition perhaps not apply to an IRA? (probably does include IRAs, but perhaps there's a clause that only applies to taxable accounts? Worth a look given the $ we're talking about).

As someone else suggested, if DW's stock is a major component of a sector ETF, you could also short (or buy puts on) the ETF, and buy calls of the other major components of the ETF....so you would be short the ETF, but long all of the major stocks in the index except for DW's company...effectively, making you short DW's company "indirectly". Might not be the cheapest way, but if you're talking about several hundred thousand $, and you think there's a chance it might crater, it could be worth a few hundreds in commissions and a thousand in volatility of the options....and these days, the options are basically just priced on volatility, given the imputed, non-existent 'risk-free rate' (hell, it's probably negative!).

But then this brings up an interesting point - if you trade the ETF, isn't that a "derivative", since part of that index includes DW's company? What about an S&P 500 fund? DW's company might only be 0.09% of the S&P, but technically, it's a derivative. What is the exact language used in the HR handbook on what constitutes a "derivative"? Same goes for a mutual fund that holds DW's stock.

If you can get away with trading a derivative that doesn't constitute more than, say, 50% of DW's stock, could you talk a broker into creating a synthetic or in-house derivative that is, say, 33% based on DW's stock? (the other 67% could be simply T-bills or some other fairly netural investment, or even an index or something else) Don't know the costs associated with this...but, again, if you think there's a good chance DW's $300,000 (or whatever) gain could go to zero based on the company's near-term success, I'd pay 5%-10% to 'guarantee' a $300k gain.

 

[FIREd]

Not trying to split hairs...but are the prohibitions specifically on your wife for trading a derivative? Or does it include their spouse? What about her parent, or your parent? A child? Also, could the prohibition perhaps not apply to an IRA? (probably does include IRAs, but perhaps there's a clause that only applies to taxable accounts? Worth a look given the $ we're talking about).

As someone else suggested, if DW's stock is a major component of a sector ETF, you could also short (or buy puts on) the ETF, and buy calls of the other major components of the ETF....so you would be short the ETF, but long all of the major stocks in the index except for DW's company...effectively, making you short DW's company "indirectly". Might not be the cheapest way, but if you're talking about several hundred thousand $, and you think there's a chance it might crater, it could be worth a few hundreds in commissions and a thousand in volatility of the options....and these days, the options are basically just priced on volatility, given the imputed, non-existent 'risk-free rate' (hell, it's probably negative!).

But then this brings up an interesting point - if you trade the ETF, isn't that a "derivative", since part of that index includes DW's company? What about an S&P 500 fund? DW's company might only be 0.09% of the S&P, but technically, it's a derivative. What is the exact language used in the HR handbook on what constitutes a "derivative"? Same goes for a mutual fund that holds DW's stock.

If you can get away with trading a derivative that doesn't constitute more than, say, 50% of DW's stock, could you talk a broker into creating a synthetic or in-house derivative that is, say, 33% based on DW's stock? (the other 67% could be simply T-bills or some other fairly netural investment, or even an index or something else) Don't know the costs associated with this...but, again, if you think there's a good chance DW's $300,000 (or whatever) gain could go to zero based on the company's near-term success, I'd pay 5%-10% to 'guarantee' a $300k gain.

Answering some of your questions will require a trip to the legal department. But basically, I don't want to take any chance and have the SEC knocking at my door.

 

[pb4uski]

...The stock *generally* moves in sync with its specific sector.....

Seems like your best bet is what brewer suggested - to buy a put on the sector. I presume that this would not be prohibited and it should provide reasonable albeit imperfect protection against a big decline in DW's employer since the profit on the put would offset the economic loss on her calls.

 

[Texas Proud]

Not trying to split hairs...but are the prohibitions specifically on your wife for trading a derivative? Or does it include their spouse? What about her parent, or your parent? A child? Also, could the prohibition perhaps not apply to an IRA? (probably does include IRAs, but perhaps there's a clause that only applies to taxable accounts? Worth a look given the $ we're talking about).

As someone else suggested, if DW's stock is a major component of a sector ETF, you could also short (or buy puts on) the ETF, and buy calls of the other major components of the ETF....so you would be short the ETF, but long all of the major stocks in the index except for DW's company...effectively, making you short DW's company "indirectly". Might not be the cheapest way, but if you're talking about several hundred thousand $, and you think there's a chance it might crater, it could be worth a few hundreds in commissions and a thousand in volatility of the options....and these days, the options are basically just priced on volatility, given the imputed, non-existent 'risk-free rate' (hell, it's probably negative!).

But then this brings up an interesting point - if you trade the ETF, isn't that a "derivative", since part of that index includes DW's company? What about an S&P 500 fund? DW's company might only be 0.09% of the S&P, but technically, it's a derivative. What is the exact language used in the HR handbook on what constitutes a "derivative"? Same goes for a mutual fund that holds DW's stock.

If you can get away with trading a derivative that doesn't constitute more than, say, 50% of DW's stock, could you talk a broker into creating a synthetic or in-house derivative that is, say, 33% based on DW's stock? (the other 67% could be simply T-bills or some other fairly netural investment, or even an index or something else) Don't know the costs associated with this...but, again, if you think there's a good chance DW's $300,000 (or whatever) gain could go to zero based on the company's near-term success, I'd pay 5%-10% to 'guarantee' a $300k gain.

If you are in the window, then anybody that is in your family that trades on the stock can cause a problem.... it is not prohibited, but I would not want to do it.... especially if the trade looked like it protected the options.... it also includes all accounts...


When I was at mega, for some reason I received access to the 'super secret' cost centers where they put things they don't want the normal folks to know about.... I got put into the window.... now, I was a mid level employee (heck, low mid level is probably closer), and I did not ever get into these cost centers.... it took me a few months, but I finally got restricted from them and got out of the window....

If you are in the window, they want to get a copy of all your investement accounts (at least my mega did)... that is EVERY account, including wife, kids etc... even if you could not buy the company stock directly....

 

[Texas Proud]

To OP....

The window opens up every quarter.... you should be able to do some selling 'soon'.... do you think that the stock can tank that much within the next 3 months

 

[Animorph]

The window is all about insider trading. It would cover spouses and anyone else who may be exposed to company information that you may know.

 

[Shanky]

Generally a trading window is closed for an employee because they are an insider. Usually the window opens several days after quarterly earnings are announced. And a solution that has a spouse or relative "hedge" for you is risky business indeed if it involves the company stock.

I have had many options expire worthless in my career, but at least the SEC never put me in jail. Regarding stock options, we appeared wealthy at times on paper, but if you cannot cash out, it is just funny money.

 

[Grainiac]

OP is talking about options that are worth of only a few hundred thousand. I could be way off but does SEC really go after "indirect maybe" kind of violators when they have their hands full with guys who are pushing the limits and making multimillion profits? Certainly I have never heard of anyone getting in trouble for playing with less than seven figures. I have never traded (directly or indirectly) outside of my window just out of the respect for my megacorp and people who insist they want me to still work there, but I have always thought that lots of this small stuff is going on and nobody ever pays attention to the small players.

 

[pb4uski]

Not sure about the options end but I seem to recall that the profits on some of the recent insider trading prosecutions were fairly modest. They commonly start out with the small fish and work their way up. Not worth the risk IMO.

 

[FIREd]

Not sure about the options end but I seem to recall that the profits on some of the recent insider trading prosecutions were fairly modest. They commonly start out with the small fish and work their way up. Not worth the risk IMO.

I agree. As I have said before, I don't want to take any chance with the SEC.

I have tried to find a sector ETF that tracked the stock price pretty closely but I couldn't find anything satisfactory to buy a put on. So I will probably just wait until the trading window reopens (a few weeks?). The stock did very well this week so hopefully we'll be able to sell at a good price.

 

[Shanky]

OP is talking about options that are worth of only a few hundred thousand. I could be way off but does SEC really go after "indirect maybe" kind of violators when they have their hands full with guys who are pushing the limits and making multimillion profits? Certainly I have never heard of anyone getting in trouble for playing with less than seven figures. I have never traded (directly or indirectly) outside of my window just out of the respect for my megacorp and people who insist they want me to still work there, but I have always thought that lots of this small stuff is going on and nobody ever pays attention to the small players.

This is a dangerous mindset that has allowed people to rationalize criminal acts. "Everybody does it", or "its small compared to what the big guys get away with" is a slippery slope.

 

[Texas Proud]

OP is talking about options that are worth of only a few hundred thousand. I could be way off but does SEC really go after "indirect maybe" kind of violators when they have their hands full with guys who are pushing the limits and making multimillion profits? Certainly I have never heard of anyone getting in trouble for playing with less than seven figures. I have never traded (directly or indirectly) outside of my window just out of the respect for my megacorp and people who insist they want me to still work there, but I have always thought that lots of this small stuff is going on and nobody ever pays attention to the small players.

Just my opinion, but if they were going after these types of trades, you probably would not have heard about it anyhow.... the small 'crimes' just do not make the paper (or I guess internet now)....


The other thing that the OP needs to be careful of is his DW's employer... I know that at my mega, if you traded outside the window you had a good chance of being let go..... think about it.... you have hundreds of thousands of dollars of extra compensation and you want to 'cheat' by hedging If I were your manager and heard about it I would say goodbye to you....

 

[MichaelB]

An insider trading violation is not an exposure in this situation. If the option holder were an insider, that would be registered at the broker that manages the company's options and they just wouldn't execute any transaction that is within the prohibited trading window.

The "do not trade" order can be a corporate policy that applies to a group of senior executives that are not insiders. In that case a violation becomes an employment issue, and the penalties can be loss of job, pension, vested options, bonuses, etc. Loss of livelihood and no lawyer can help.

 

[Grainiac]

Just my opinion, but if they were going after these types of trades, you probably would not have heard about it anyhow.... the small 'crimes' just do not make the paper (or I guess internet now)....


The other thing that the OP needs to be careful of is his DW's employer... I know that at my mega, if you traded outside the window you had a good chance of being let go..... think about it.... you have hundreds of thousands of dollars of extra compensation and you want to 'cheat' by hedging If I were your manager and heard about it I would say goodbye to you....

I was not suggesting that OP's wife should play with fire laugh: pun intended). I would never do that either. Rather I just wanted to speculate how common the small violations might be out there. Just for an example: My megacorp stock is currently in three separate stashes: indirectly through stock options, in 401(k) and other deferred accounts, and in my brokerage account. My megacorp obviously knows about the first two, but I have never told them about my brokerage account and I have never told my brokerage who my employer is and even if they knew about it there is no public information about who is formally considered an insider within my megacorp. How would SEC find out? Do they have access to every public company's employees' social security numbers and a way to link them to the ss# behind every single stock trade made? My megacorp average volume indicates that over million shares of its stock is traded during a average trading day and there are hundreds of companies with much larger volumes. Is there really a system that somehow looks into every trade done as a potential insider violation?

 

[Grainiac]

This is a dangerous mindset that has allowed people to rationalize criminal acts. "Everybody does it", or "its small compared to what the big guys get away with" is a slippery slope.

Funny you are reading much more out of my comment than I thought I ever wrote into it.

 

[ziggy29]

The other thing that the OP needs to be careful of is his DW's employer... I know that at my mega, if you traded outside the window you had a good chance of being let go..... think about it.... you have hundreds of thousands of dollars of extra compensation and you want to 'cheat' by hedging If I were your manager and heard about it I would say goodbye to you....

And at my mega, ALL options trading on company stock, except for exercising company-granted stock options within the allowed trading window, is *completely* forbidden at all times. The trading window closes 3 weeks before the end of a quarter, and reopens 3 trading days after earnings are reported for the previous quarter.

(Edited to specifically qualify my statement by referring only to employer stock.)

 

[FIREd]

When the trading window is closed, the option brokerage account is locked anyways and all trades will be denied.