Hi guys,
Does the forward conversion with option actually involve a collar? (long put, short call) Do you own those shares?
Why is there no counterparty risk involved?
Is tax avoided in the sense that you are not “selling” the shares, but using them to cover the call obligations, should the shares be called?
Thank you a lot!
You could say it’s a collar but the strike price of short call = strike price of long put. Yes, the investor owns the shares.
There is counterparty risk in the long put position (unless the put option is exchange-traded). The position is “riskless” from a market/price risk perspective as any movements in the share price will be offset by the (long put,short call) position.
Since the share value is protected from a drop below the strike price (by the long put), there is no rush to sell off the shares, hence the taxable event can be avoided for now. And for the short call positions,
If the share price increases above the strike price of the call, then the shares owned by the investors will be delivered to the call holder.
You can think of it as a degenerate collar, if you will, but it’s probably better to think of it as a synthetic short position.
What’s “degerate”?
It’s an economical form of “degenerate”, written by someone who just got a new surface book computer and is still acclimating to the keyboard.
I fixed it, above.