Simple method to hedge an employer’s stock

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Topic Author
Olgadog1035
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Joined: Tue Dec 21, 2010 10:32 am

Simple method to hedge an employer’s stock

Post by Olgadog1035 »

For complicated reasons that aren’t relevant here, my wife is loath or terrified to change her portfolio which is heavy in her company stock. It comprises less than 10% of our combined portfolio, but the majority of her individual holdings. Assuming she opts to hold it forever is there any way I can hedge against it collapsing? The rest of our combined portfolio should be fine if this happens, but if there are simple steps I can take to guard against something like that, I’d love to consider it. Thanks for any thoughts on this.

Cheers
skibbi9
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Post by skibbi9 »

buy out of the money put options on the stock for some fraction of her holding

this only works if her company is pretty liquid, has an option demand and is domestic (i wish my company was listed domestically)
grberry
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Post by grberry »

Be careful here.

1) Some very senior corporate employees are required by U.S. law to profit any gains from hedging or shorting transactions related to their corporate stock to the company. If she is in this position, the result is heads the company wins, tails you lose, and either way you pay to place the bet. Don't take that bet.

2) Some companies also have a policy applying to all employees prohibiting hedging and shorting. For the purpose of policies limiting employee transactions, transactions by their immediate family also count. So you could cost your wife her job if these transactions are found out about.

Is the risk of the company learning real? Yes, absolutely. If there is a news event that suddenly drives the company stock price down there probably will be a regulatory inquiry into whether or not there was insider trading. (Only a tiny fraction of regulatory inquiries turn into enforcement actions, and only some enforcement actions make the news.) In these inquiries, the agency will inquire of brokers who had gain transactions near the date and time of the news event. Then they will ask the company if any of these people are either a) employees, b) known to those people senior enough to have known before hand. Lots of managers will have to review every name on the list - if your name or your wife's name is there, the transaction will be known. So the exact times for which you most want to be hedged are the times when the company is most likely to learn that you were. And with a regulatory inquiry underway, they are not likely to be merciful at that time.
Topic Author
Olgadog1035
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Post by Olgadog1035 »

grberry, thanks for the excellent information. Based on the downside potential for hedging, I suppose I'm back to looking for gentle opportunities to bring up diversification with my wife. Perhaps over a candle-lit diner?

Cheers
Bob's not my name
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Post by Bob's not my name »

Sure: if she insists on holding onto this stock, all she needs to do is change employers to reduce her exposure to a single company. Way easier than selling some stock.
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Scott S
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Post by Scott S »

Hasn't she heard of Enron? :wink:
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fredflinstone
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Post by fredflinstone »

There might be good reasons why your wife doesn't want to sell the stock. You say she has reasons but that they are "complicated" and "not relevant here." This leaves me wondering what those reasons are.

One time, my wife Wilma bought stock in a company that makes Wooly Mammoth vacuum cleaners. I begged her to sell it, but she would not relent. Rather than sleep in Dino's doghouse for the rest of the week, I let her win the argument.

Image

But seriously, while it would be nice if your wife agreed to sell the stock, it's not the end of the world if she doesn't. With less than 10% of your overall portfolio at risk, this is one of those cases where the Boglehead philosophy may have to take a back seat to your wife's preferences for the sake of marital harmony.

In the meantime, it might make sense to leave The Bogleheads' Guide to Investing lying around where your wife might see it.
Stocks 28 / Gold 23 / Long-term US treasuries 19 / Cash (mainly CDs) 22 / TIPS 8
hlfo718
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Post by hlfo718 »

Just remind her of Enron, Worldcom, Lehman, Bear, Sunbean, General Growth (but alive again), and dozens of other companies that disappeared or value of the stock dropped substantially.

Why not sell off x percent each year and put the proceeds in an index fund so she still has market exposure without the concentration risk?
xerty24
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Post by xerty24 »

The simplest thing is to sell some. Check to make sure she's allowed to do this by her company. Alternatively, you could short some in a different account and generate a net reduced or zero position. Note that this will be capital inefficient and will generate tax consequences equivalent to a sale. Anything else, like options, will be very expensive to do, esp over the long term.
Topic Author
Olgadog1035
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Post by Olgadog1035 »

fredflinstone, I think you're probably right on the mark. The agony associated with this issue isn't worth it for the percentage of our combined portfolio. I've been able to balance our assets "around" her holdings anyway. But I'm turning into a belts and suspenders kind of guy, so if there were also a way to protect against her holdings, it would have been nice. Just more proof that there's only so much control we can exert over finances.

Cheers
Valuethinker
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Post by Valuethinker »

Olgadog1035 wrote:fredflinstone, I think you're probably right on the mark. The agony associated with this issue isn't worth it for the percentage of our combined portfolio. I've been able to balance our assets "around" her holdings anyway. But I'm turning into a belts and suspenders kind of guy, so if there were also a way to protect against her holdings, it would have been nice. Just more proof that there's only so much control we can exert over finances.

Cheers
If you do work out a hedging strategy, make sure you clear it with your company's compliance department/ company secretary/ CFO's office.

Get it in writing that you did so (ie email and then follow up with a letter if necessary). If someone gives you a verbal nod on the phone, send them an email post conversation stating what you think they told you and ask them to confirm. Even if they do not reply, you are in a lot better legal shape than hearsay: the court would look at that and say that it is unlikely you sent that email if you had not had the conversation, and the other side did not object.

The SEC looks into these kinds of things. You want to make absolutely sure that you have cleared the path, and that authorities within the company have agreed that you could follow your intended strategy. Otherwise you can have all kinds of bad things happen: insider trading charges, banned from securities dealing for life, fines, imprisonment-- losing you or your spouse's job would be, more or less, the least.

Although it is senior officers that the law and the SEC are most concerned with, their are situations when employees at any level may be insiders. And companies, as pointed out, have their own internal policies (HR is probably first point of call on this).

Any kind of derivative transaction against a stock like an option is tantamount in some circumstances to trading that stock.

With your wife, you want to talk about Enron-- the movie 'Smartest Guys in the Room' has a lineman who lost his entire savings when his utility (Portland G&E I think) was taken over by Enron, his stock in 401k converted to Enron stock, which was riding high, and went to zero.

The moral is that you can work for a good and reputable company, a market leader (see Nortel), and lose everything when the wrong people take over the company, or rise to leadership of the company. Nortel was once the largest company in Canada by market capitalization-- over 15% of the Canadian index.

Similar stuff happened at Nortel (accounting fraud, and now the pension fund is insolvent), Worldcom etc.

You might show your wife Smartest Guys in the Room.

If she's uncomfortable selling *all* her stock, selling *half*. 'Take money off the table' also known as 'split the difference'.

Although it sounds trite, there is a huge amount of psychological and finance theory that says that when faced with an indeterminate financial decision, taking half your money off the table is a good answer. You can never then be entirely wrong, nor entirely right.
Valuethinker
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Post by Valuethinker »

Olgadog1035 wrote:grberry, thanks for the excellent information. Based on the downside potential for hedging, I suppose I'm back to looking for gentle opportunities to bring up diversification with my wife. Perhaps over a candle-lit diner?

Cheers
Another thought is that you suggest she sell some stock, and direct the proceeds towards:

- retiring the mortgage
- college savings/ costs for children

In other words create a 'towards' with the money, as well as an 'away from' vis a vis risk.
Topic Author
Olgadog1035
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Joined: Tue Dec 21, 2010 10:32 am

Post by Olgadog1035 »

valuethinker, "the hedge" really sounds like a lost cause now that I'm aware of all the complications involved in attempting it. However, I love your idea of watching the Smartest Guys in the Room with her; very subtle and gives her the opportunity to realize the danger without ME being the preacher. Thanks for you advise.

Cheers
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