equity collar

question regarding equity collar ( for low basis stock ) the cfai text book tells the atrractiveness of monetized collar as " deductibility of interest paid on borrowings associated with collar ". last year’s exam asked us to choose the one that has no leverage effect, and the answer was collar. but if you read the text book, it gave the attractiveness as interest on borrowings, but how do you borrow for what, i mean, isnt there borrowing = result in leverage effect ? ???

I have not read the exam question but this is how I would answer it. You are allowed to borrow for up to 90% of the put values ( long puts - short calls) . There is no leverage involved since you’re not borrowing for more than the value of your stocks but for only up to 90% of the puts value.

thanks mo, you certainly cleared up my question. should i understand that this 90% apply to VPF as well ? and has no leverage effect as well ?

According to the reading you are allowed to establish the collar but you have to maintain a 15% risk exposure for the portfolio as a whole. So you can’t just totally hedge your concentrated position. This is the first step, to establish the hedge. The next step is to get money out without triggering taxes. This is done by borrowing for up to 90% of the puts value, which if you hedged the maximum allowed ( 85% of your concentrated position) , it would be 90% of that 85%. I don’t think we need to know all these details, just keep in mind that it’s a two step process with no leverage. First step hedge, second step get money out without paying taxes.

which ss is this reading coming from? tks

honestly that was my question too :slight_smile: equity collars, I know but equitizing and leverage…no clue

trymybest Wrote: ------------------------------------------------------- > honestly that was my question too :slight_smile: equity > collars, I know but equitizing and leverage…no > clue Exactly what I’m wondering… and I thought I was the only one who had no clue what’s going on here :slight_smile:

Low basis stock. I don’t think Schwe. covers so much details in this reading, you have to go to the CFAI readings for this one.

thanks

  1. interest paid on the borrowing is tax deductible. 2. since the loan was made against the low-based underlying, the owner basically sold out portion of his holdings (max. 90% x 85% = 76.5%) at a price equal to the put strike without paying a single penny of capital gain tax. the real cost of this monetization scheme is the premium for the protective put. the closer to the money, the higher the cost, of course. but, this cost can still be offset by income from the covered call and tax deductions. (note: the person shouldn’t forget to pay a couple of bps to the cfa who helped to craft out this scheme) afterall, it’s just nice being wealthy …