Most advisers claim that you need extra cash

or assets to hedge your ESOs. There is a way

to do it without extra cash or assets.

Assume that you own vested employee stock options

to buy 500 shares of Entergy Corp at $40.00 per share.

The impied volatiity is 20. There are 4 years to expiration.

The shares have advanced to $110.00 on May 25, 2007,

giving the 500 ESOs an intrinsic value of $35,000.

Although you still have a small "time premium" that would be

forfeited if you exercise now, you may want to reduce the risk

because you worry that the stock is too high. But you

have no extra cash for margin to sell listed calls or buy puts.

Here's a way to manage those positions without adding

cash or other assets

1. Make a premature exercise of 60 options and sell the

stock. Take the $4200 intrinsic value and deposit it into

a traditional IRA, if you have not already deposited the

yearly maximum in your IRA there would be no tax on

the $4200.00 because you are allowed a deduction for

the deposit.

You now hold just 440 ESOs.

Take the $4200 proceeds and either sell three slightly

out of the money Entergy calls or buy puts. Or buy put

verticals where you buy puts that have high strike prices

and sell puts that have low strike prices (i.e. a bearish

put vertical in exchange lingo).

Selling calls in an IRA is not prohibited, contrary

to what most say. But most brokerage firms will not

allow selling naked calls. So you may have to sell

vertical call spreads instead or buy puts or put verticals.

If you are correct and the stock declines, the gains

from the sale of listed calls or the purchase of puts

will offset some or all of the loss on your ESOs and

will be non taxable currently.

If you have larger positions, you can do the same each

year and gradualy have a larger position hedged.

So there you have it, you reduced risk, avoided an early

tax and forfeited just a small amount of "time premium"

and you did it without having used any other assets.

If you have free assets in your IRA and are already making

the maximun contribution, there is no need to make any

premature exercises and sales, just sell call verticals or

buy puts using the free assets as margin.

Selling the call verticals gets you negative deltas without

exposing you to changing volatility ot interest rate risks and

is generally accepted as a way to hedge inside of an IRA. Give

your broker a limit spread order.

Avoid premature exercises if you can. Premature exercises

causes forfeiture of time premium and a premature tax liability.

Section 1092 Straddle Rule

Some tax experts claim that selling calls or buying puts

versus ESOs creates a Section 1092 straddle.  I am confident that

the straddle rule would not apply to hedges versus the ESOs.

 

Good luck:

John Olagues

504-305-4449

http://www.brighttalk.com/dcemail_redirect/webcast/5906

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