High-net-worth investors with a concentrated position in a low-basis stock often wish they could use its value to diversify their portfolios or to purchase other assets without selling their position and triggering substantial capital gains.
What is Optic Equity Access?
Optic Equity Access is a strategy that helps investors tap into the equity in their large, single-stock positions without selling their shares and incurring a large tax bill. The strategy uses an options collar to secure a “cash-out” advance that the investor can use for whatever purpose they like.
Key Features
- Upfront Payment: Investors receive a lump sum payment, typically around 85-90% of the current market value of their shares and significantly higher than a traditional margin loan. Investors often use the cash to purchase an asset or diversify their portfolios.
- No Sale Involved: No capital gains tax is triggered when the loan amount is received because investors still own the stock.
- Options Collar Protection: As with any collar, a put is purchased to hedge much of the investor’s downside. Its strike price protects the amount borrowed and secures the lender’s position. On the other side of the collar, a call option is sold to pay for the put. While this technically limits the stock’s upside, active management of the position can provide flexibility in rising markets.
- Ownership and Rights: The investor retains ownership of the stock, allowing him/her to exercise voting rights and receive dividends.
- Settlement Flexibility: At the end of the contract, the investor can choose to pay off the loan or roll forward into another set of collars.
Hypothetical Example: Using Optic Equity Access
Sarah is a hypothetical high-net-worth investor who holds a substantial position in XYZ Corporation, a tech company she invested in early. Her shares in XYZ have appreciated significantly, and her position is now worth $10 million. She is bullish on the stock and wants to keep it. But she also wants to diversify her investment portfolio because XYZ’s rise in value has resulted in concentrated risk and a lack of balance. Moreover, her cost basis is very low, and she is concerned about the large capital gains tax she’d incur if she sold any shares.
Optic Equity Access
Sarah decides to implement the Optic Equity Access strategy as she seeks to unlock the value of her shares without selling them.
Step 1: Selecting the Collar and Amount
Sarah works with her personal tax advisor and Optic Asset Management to choose an options collar that fits her risk tolerance and investment goals. She decides on a collar that allows her to access 85% of the value of her XYZ shares, or $8.5 million.
Step 2: Receiving the Upfront Payment
Once the collar is established, Sarah receives an upfront lump sum payment of $8.5 million from her custodian, who has offered the loan because it is collateralized by the collar position on her stock. The $8.5 million is significantly higher than what she would have received through a traditional margin loan.
With the funds in hand, Sarah uses the proceeds to invest in a diversified portfolio, potentially reducing the concentration risk of her holdings. This move allows her to try to balance potential returns across various asset classes while still maintaining her substantial position in XYZ Corporation.
Step 3: Retaining Ownership and Rights
Sarah also retains ownership of her XYZ shares. This means she can continue to vote on corporate matters and receive quarterly dividends from the company, maintaining her active role as a shareholder.
Step 4: Term Conclusion Options
At the end of the term, Sarah has a couple of options:
- She can pay off the loan with cash.
- She can try to roll forward into another set of collars at the market prices that exist at the time. She will need to consult with her tax advisor again to ensure that she understands the implications of rolling forward under the new terms.
By choosing Optic Equity Access, Sarah successfully defers capital gains taxes, gains much-needed liquidity, diversifies her portfolio, and protects her sizable investment through strategic risk management.
(Note: This is a hypothetical example for illustrative purposes only and Sarah is not an actual client of Watts Gwilliam & Company nor its Optic Asset Management division. Each individual’s situation is different and investors should consult with a financial advisor and a tax advisor prior to entering into any investment strategy.)
Risks and Considerations
When considering the Optic Equity Access strategy, it is crucial for investors to understand the associated risks and considerations involved. Here’s a breakdown of a few of the key factors to keep in mind, and investors are encouraged to review all of the disclosures that they are provided with prior to proceeding with the strategy:
Market Risk
Stock values may vary during the contract term. Although a collar offers some downside protection, market fluctuations within its limits still pose a risk. Furthermore, if the stock value rises quickly, the investor might have to buy back the call option to retain their shares, potentially leading to financial loss.
Dual Investment Risks
Reinvesting proceeds from the Optic Equity Access strategy into other securities can introduce additional risks. This includes increased portfolio leverage and heightened exposure to market volatility. It’s important to note that both the collateral stock and any new investments could potentially lose value simultaneously.
Tax Considerations
Investors should consult a tax professional prior to investing to understand how the IRS may perceive and tax each element of the strategy. Although the strategy is expected to allow for the deferral of capital gains taxes, these taxes will still be applicable upon the eventual sale of shares. Dividends received during the contract period may be taxable as income. Other taxes may apply as well. On the other hand, interest expenses on the loan may be deductible under certain conditions. A tax advisor can assist in navigating these complexities and help investors plan effectively.
Fees and Other Costs
Investors should be aware of potential fees and costs associated with Optic Equity Access, which will be fully disclosed prior to implementation. These include management fees, transaction fees, and costs associated with the collar position. Additionally, there are costs associated with the loan that will depend on the specific terms offered by the lender. Each of these costs will significantly impact the overall performance of the strategy.
Not a Prepaid Variable Forward Contract
While similar in some ways, the Optic Equity Access strategy is not a Prepaid Variable Forward (PVF) contract. A PVF typically involves an agreement to sell a variable number of shares at a future date while receiving an upfront payment, often introducing more rigid terms and the potential relinquishment of stock ownership rights.
Conclusion
For those holding a large stock position with a low basis, the Optic Equity Access strategy offers a method to access equity without selling shares, thereby avoiding immediate capital gains taxes. This approach can be especially appealing for individuals looking to fund significant purchases or to diversify away from a concentrated stock position. If you are a high net worth investor with large, low-basis positions in one or more stocks, please contact Optic Asset Management to learn more today.
Disclosures
The information provided regarding the Optic Equity Access strategy is for informational purposes only and should not be considered financial advice nor an offer or solicitation. The hypothetical example included does not represent any actual client of Watts Gwilliam & Company nor its Optic Asset Management division. The strategy discussed may not be suitable for all investors. Prospective investors should conduct their due diligence and consult with a qualified financial advisor before engaging in this or any investment strategy. The performance of stock investments can vary, and past performance is not indicative of future results.
Investing, especially with options, involves risks, including the potential loss of principal. The use of an options collar strategy may not provide complete protection in a declining market, and there is no assurance that the strategy will achieve its intended objectives. Investors must be approved for options trading by their brokerage/custodian and read all disclosures, terms, and contracts provided, including the CBOE’s Characteristics and Risks of Standardized Options. Optic Equity Access involves significant fees, interest charges, and other costs which will negatively impact its performance over time. Using the loan proceeds from the strategy discussed above to make other investments will create the risk of additional financial loss on those investments, plus it will potentially result in additional fees, some of which Optic Asset Management would not otherwise be able to charge, creating a potential conflict of interest. Tax laws are complex and subject to change; therefore, individuals should consult with a tax professional to understand the tax implications that may arise from the use of this strategy.
