LinkedIn Group Established for Equity Compensation Recipients

On Jan 20, 2009, Mr. Williams  of J.P. Morgan was granted SARs to purchase 700,000

shares at 19.49. On September 9, 2009 JPM was trading for $42.65. I recommended

that  3000 Jan 11 calls with an exercise price of 50 should be sold at $450 each, which

reflected an implied volatility of 57. I also recommended buying 800 Jan 2011 puts

with an exercise price of 45 for $ 920. The purpose was to reduce risk, enhance

earnings and to reduce taxes associated with the ESOs.

The stock of JPM has gained 2 points since since I made the recommendation. The

ESOs have gained $1.10  in theoretical value, the 3000 calls have dropped $1.25 and

the 800 puts have lost $3.1 .

The summed totals follows:

+$770,000 on the ESOs not currently taxed

+$375,000 on the 3000 calls sold

-$248,000 on the 800 puts owned

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+895,000  Total gain before any tax consideration.

And the $248,000 loss if liquidated can be used currently against taxes either as an ordinary loss under section 1221 or a capital loss if 1221 did not apply.

I would recommend that the following adjustment should be made. Sell the 800 Jan 2011 (45) puts to take the loss and buy 800 Jan 2012 (50) puts at appropriate prices.

This scenario illustrates how hedging often works. The stock is higher and the trades that were made to protect against a down move actually made a combined profit but we show a tax deductible loss.

While it is true that those trades were designed by an expert, anyone who wishes to do it himself can by reading our book, which will be in the bookstores on Jan 12, 2010. See link

http://www.wiley.com/WileyCDA/WileyTitle/productCd-0470471921,descCd-google_preview.html

John Olagues

On September 9, 2009, I made two recommendations for hedging strategies trying to clearly demonstrate that hedging is the superior way to manage ESOs.

Those examples are in J.P. Morgan and Google as was described on this discussion forum.

J.P.Morgan

I took an executive who received 700,000, SARs with an exercise price of $19.49 on January 20, 2009. On September 9, 2009 with the stock at $42.60 I recommended the sale of 3000 Jan 2011 calls with an exercise price of 50 for $450 each. That was the market price at the time. I also recommended the purchase of 800 Jan 2011 puts with an exercise price of 45 for $920 each. That was the market price at the time.

Today, April 3, 2010  the stock of JPM is $45.20. The calls are trading at $260 and the puts are trading at $490.

So what is the result if we made no adjustments.

The 700,000 ESOs are up about $2.60 as their value increased with the stock advancing and interest rates increasing, even though implied volatilities decreased.

Increases value on ESOs $1,820,000.

The 3000 calls are lower by $190 each making a

Gain of $570,000

The 800 puts are $420 lower making a

Loss of $336,000

The total is an increase in value of $2,054,000.

If today the executive sold the puts and bought other puts that are not "substantially identical", he could report a current loss probably against ordinary income of $336,000 if the put purchase was designated as a hedging transaction versus ESOs.

That's not a bad result.

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Google

On September 9, 2009 with Google trading at $464, we recommended selling 200 Jan 2011 calls exercisable at 520 for $5050 each versus 34,100 long ESOs, with an exercise price of 318.

Today April 3, 2010, Google is trading at $568.80 and the calls are trading at $8360 per contract.

The 34,100 ESOs have an increased value of about $3,200,000

The the sale of the calls show a loss of $662,000

Total increase in value of $2,538,000.

If the calls were purchased back and other calls were sold that are not "substantially identical" then the loss of $662,000 is reportable currently if the hedging transaction versus the ESOs was designated.

Again a very good result.

In these two example we assumed that each executive had stock in the company (or other capital assets) and other vested ESOs to cover any requirements for margin and to comply with SEC Rule 16c-4.

Had the executives made early exercises, sold stock and diversified, they would be far behind the hedging executives and will continue to fall further behind over time.

These two examples are not the only successful examples but are typical results.

There are those who will claim that my readings of the margin rules, the SEC rules and the tax rules and provisions in corporate documents  are incorrect. But none will specifically mention their correct readings of such rules and documents.

WHY!

John Olagues

Truth In Options

http://www.optionsforemployees.com/articles

olagues@gmail.com