Can I “hedge” my NQOs by using traded options?
January 22, 2003
Date: Mon, 02 Dec 2002
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?
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.