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Date:   Mon, 02 Dec 2002
From:   Andrew

I was laid off last week holding a truckload of underwater options. I've been given one year to mess with them (they're exercisable). I had an idea which I'd like to hear about from people here.

In my case, my offer price is about 70% above the current price, and there is a chance, albeit in my judgement a faint one, that in 12 months they can actually turn a profit as opposed to being worthless. But this is a slim chance.

Here's the idea:  hedge the options with real options. I can play numerous games with the term and the strike price, but the basic idea is to leverage my potential long position, just as a farmer would when looking ahead to sell next year's corn crop, and hedge it on the short side. I can buy puts, or I can sell calls. There is no free lunch, so this is a gamble. A range of prices exist which guarantee I lose. Nevertheless, does anyone have any adeas about how to minimize risk and maximise profit in a situation like this?

-Andrew

Answer

Hello Andrew,

It appears to me you can hedge unexercised NQOs. However, you need to be careful that the hedge is not deemed to be a sale. A wash sale may be deemed to be a sale, because the selling price and closing date are certain. Some straddles are deemed to be sales. (Internal Revenue Code Section 1259 and regulations thereunder.) According to regulations section 1.83-1-(b), a sale of the option results in recognition of ordinary income.

I have a problem with hedging unexercised ISOs because it seems to me the IRS can claim the holding period from the grant date is suspended or lost when there is an offsetting option position, especially a purchased put or short sale.

These are complex rules. Get some help.

Good luck!

Mike Gray

For more information about non-qualified stock options, request our free report, Non-Qualified Stock Options - Executive Tax and Financial Planning Strategies.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this answer was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.