Using Options as a Hedge for Concentrated Holdings

One of the major worries of someone working for a public company is that most of their net worth will be tied by the fortunes of that company alone. This is especially prevalent in tech companies. Many ask whether it’s in their best interest to diversify into something else. While it is usually easy to say yes, diversifying can be a double edged sword. The company can grow quickly and its valuations can continue to skyrocket. In these cases, the opportunity cost of you not tying your investments with a company you know is tremendous – something you’d probably ignore because you probably don’t want to go back and do the calculations and see what you’ve missed.

I think a good idea to this problem is to use long term options as a middle ground between these two sides. While most people think to protect their stock position they have to use puts, I’d argue using a long term call option (LEAPS) in this instance has the ability to waste a lot of money on premiums.

I believe using LEAPS can protect your concentrated position because you gain an option to purchase the stock at a price in the future without you tying up all of your capital. You can sell all of your stocks in the company and at the same time purchase enough LEAPS to match the value of your position. For example, if you have 10,000 shares of Apple, at a market price of say $179.04 (as the date of my writing), you can purchase a 100 call options of Apple dated 1/19/24 at $180 for about $32. The original value of position was $17,904. You’ve spent $3,200 to buy this call option instead, which is only 17.87% of your capital. You are left with $14,704 in cash to invest into something else.

Of course, the problem with buying the long dated call option is that in order for you to break even, the stock has to rise above $212. So the stock has to rise at approximately 8.2% a year in order to reach that point. While it does seem to be expensive, but the key is that any subsequent rise in that stock would be compensated by the fact that any rise after 212 would be multiplied. In fact, you’d get about 6.6x return for every 1% rise above 212. Don’t forget the main goal here. We don’t want to miss out a strong rise in the company’s stock price if you are being paid in stock by the company. It is almost like buying insurance for the future where you won’t miss out on your company’s further success.

With the remaining $14,704, you’ll be free to use it to diversify your investments into something else – whether that can be bonds or index funds. If you’re more bullish, I’d suggest buying index funds as that’d serve your intention to diversify your investments. If you’re more bearish, you could purchase some US treasuries, possibly short term ones, so that you can react quickly to opportunities should they appear before 1/19/24. I would go with index funds.

Hopefully that gives you an idea how using options can create a middle ground in these types of situations.

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