strategy for diversifying out of a single stock

[nuisance]

The company I work for went public, and I own 7 figures worth of shares, comprising 85% of my net worth. That's not a percentage I'm happy about (although the figures worth is pretty awesome). The lock-up period expires in Q4, so until then I can plan how best diversify my holdings. There are some conflicting concerns in getting there:
1. Historically, new stocks take a dive when the lock-up period ends.
2. For taxes, it's much better to spread things out over multiple tax years. (I'm already in long-term cap gains.)
3. For diversification, it's best to sell ASAP. What if the stock takes a permanent dive?

Similarly, I have a bunch of unvested options, for which all the same concerns apply.

I'm curious how other people have approached this problem. Does a firecalc-like tool exists that can evaluate several strategies against real-world lock-up-expiring data. (Does that data even exist? Can I download lots of raw stock data somewhere?)

 

[Ed_The_Gypsy]

I would go for #3. I have seen people suffer mightily being so concentrated. Forget the tax consequences, you should be more concerned with capital preservation. If you are conflicted, convert half now, half next year. That way you are only risking half of it.

 

[Animorph]

I diversified out of a similar position during 2001-2002. Being a novice I didn't think about diversifying too far away and stuck pretty much with individual tech stocks. I looked for stocks where the share price relative to the shares I was selling was hitting new lows. I also screened for stocks I liked, including a low debt load. So I screened for stocks I liked and then bought them if their price over my company stock price was at something like a one year low. So I diversified by company, but not so much by sector since I mostly favored other tech stocks.

It worked out great anyway. I stopped tracking my results when I was about 15% ahead by selling my company stock and buying the other stocks. When tech recovered and I wanted to go international, I switched over to mutual funds and gave up individual stocks for the most part.

By all means pay close attention to taxes. Going above 250k AGI will be a problem, and AMT might be as well. In my case I had to deal with deduction/exemption rollbacks that increased my marginal LTCG rate. I actually took enough capital gains one year to get over that hump and get back to the 15% rate. I don't remember any rates above 15% after the hump. All different now.

Depending on how bad the tax hit is, I'd definitely lean towards favoring diversification, even if you have to pay a little extra in taxes. Don't extend this into some 10-year plan. If the company stock hit new highs, sell some. Maybe you're saving 5% in taxes by waiting, but the market can cost you that pretty quickly.

 

[FIREd]

With 7-figures in that one stock, it will take years to diversify in a tax-efficient way. In this situation (85% of NW in one stock), I think that diversification takes precedence over tax efficiency. So I would not concern myself too much with taxes - especially if, as you mentioned, you only have to pay LTCG taxes on the proceeds.

In our case, we decided to sell a big chunk ASAP and let the rest ride out the market. We are comfortable with that one stock weighing up to 30-35% of NW. If it goes over, we sell another chunk.

 

[jebmke]

Are any puts available on this stock?

 

[pb4uski]

I was wondering the same thing - whether it is possible to mitigate part of the risk of owning such an undiversified position through some options strategies.

 

[RHLnFLA]

 

[RockyMtn]

#3. Remember Enron.

 

[2B]

If options are available for this stock, I'd consider hedging with puts. If you buy significant out of the money puts (15+%) you shouldn't have to pay too much for that. You would be protected against a total disaster.

How long? It depends on how many years out have puts available. Five years is about the longest I recall seeing. You didn't say how far you are into 7 figures but you can probably get away from some of the real high tax rates and ACA driven taxes.

This strategy would limit your downside for a price but you'd have upside opportunities intact.

Congratulations! You are one of the very few people I would recommend seeing a CPA tax specialist. You got a big pile of money sitting there. This isn't something I'd trust to a simple tax program although you may want to play with variations of your cash out options. You need a professional's opinion on this.

 

[clifp]

As others suggested the use of options is a common way of dealing with this problem.

I fairly common strategy is to use what is know as a collar. So for example lets say the stock is currently selling for $50, and your cost is $10.

You would buy a Put that expires in say December at price of say $45. You'd pay for that put by writing a covered call at say $55. This would guarantee that you get a least $45 through the lock up period, but if the stock continues to go up you limit your upside to $55. (But since you only paid $10 hardly something to cry about it.)

For your option which say vest next year, you maybe able to sell a long term option (called a LEAP) and do the same thing buy buying a Jan 2016 45 put and selling a Jan 2016 55 call.

I agree with 2B given the amount of money, and the vast complexities of the tax laws especially with complexity of alternative minimum tax, I advise consulting a CPA.

In looking for CPA you want to find one that is familiar with employee stock option as well as the use of public traded options.

At one point Intel stock was 75%+ of my net worth. A couple of years before retire (actually year before I even thought of retiring) I made concerted effort to diversify by the time I completed the program in Jan 2000 I was down to 30% (despite run up in the stock price, more options vesting and employee stock purchases). I was very glad I did because Mr. Market reduced that figure to below 10% when the stock went from 70 to 20.

 

[MichaelB]

Make sure to read the employee stock and stock options agreement terms to make sure trading in company stock or derivative products is not prohibited.

Also, be careful when hedging unvested options, as some employers reserve the right to withdraw them.

 

[clifp]

Make sure to read the employee stock and stock options agreement terms to make sure trading in company stock or derivative products is not prohibited.

Also, be careful when hedging unvested options, as some employers reserve the right to withdraw them.

I was going to add that but forgot. You also don't want to run a foul of your companies policies, and their investment bankers.

 

[nuisance]

Thanks, everybody! I'll definitely do some research into options. I feel pretty out of my depth there, but nothing I can't learn... Are there any books you particularly recommend?
I've already got a CPA, so at least I'm doing something right. In fact it's talking to him that's made me think harder about a diversification strategy.
I'm well aware of limits on options. Until the lock-up ends I'm not allowed to do anything at all, but at that point I should be able to use the collar strategy clifp describes.

 

[FIRE'd@51]

I would talk to a bank or brokerage firm about entering into a swap agreement whereby you swap the return on your stock for the return on the S&P 500.

 

[clifp]

I haven't personally purchased this book but Fairmark.com is my go to site when I need good tax advice and I'm too cheap to pay a CPA.

This book , consider your options in particular looks helpful.

 

[nuisance]

I've read Consider Your Options. I really like it. Doesn't talk much about the technicalities of investing though.

 

[nuisance]

I would talk to a bank or brokerage firm about entering into a swap agreement whereby you swap the return on your stock for the return on the S&P 500.

Is that a real thing? Where do I sign?