Monetization of a concentrated position

CFA Level III Portfolio Management
#1

The text says that monetization involves “receiving cash without triggering a tax event”.

However, when you look at the tools involved in the monetization process, especially when you hedge your position and then borrow against the collateral of the hedged position, every one of them will, in the end, trigger a tax event.

  1. Short sale against the box: If the short sale goes against you, you’d have to sell your own shares to make up the loss on the short sale. That would trigger a tax event AND affect your concentrated position (that you did not actually want to dispose of)

  2. Equity forward sale contract: This will, at the end of the contract, involve a sale, and therefore, both a tax event and will affect your concentrated position (that you did not actually want to dispose of).

  3. Forward conversion with options: buying puts and selling calls - now at expiry or execution, both will involve you disposing of the shares and triggering a tax event.

How does this add up? The point of monetization is to raise cash without triggering a tax event, but in these cases, it does trigger a tax event AND it affects your concentrated position as you may ultimately have to dispose of the stock.

Regards,

#2

Hi,

You are assuming an actual delivery of the stock - at the end of the period the profit/loss is calculated as the difference between the end of the settlement price and your entry price (and there need not be an actual sale of shares). If there is compulsory delivery of stocks on expiry you can simply net off the position so as to avoid delivery and hold on to the stock. On the profit/loss of such a closed position you would be taxed - now how that is done is regulator specific - could be long term or short term tax or could add / reduce the cost basis of your shares.

The idea is that you have shares that you want to hold on to, hedge it, borrow against it and reinvest it in something else. Know the different ways in which it is done, the advantages and disadvantages of each method and this should, in my opinion, be enough for the exam.

Hope this helps.