The Striking Price

Getting Ready for a Forgiving 2015

STEVEN SEARS

Saturday, November 8, 2014

The global flood of central-bank cash is a lift for stocks. Beaten-down equities could rise next year. How to play that with tax losses and options.

A reader from California recently quipped that we are living in a Bob Marley “Everything’s Gonna Be Alright” kind of global economy.

His cynical one-liner made me chuckle. Japan’s central bank had just aggressively increased its easy-money policies. Stocks jumped higher on the news, and I imagined scores of dark-suited central bankers enjoying popular Rastafarian pursuits that are illegal in most countries.

Naturally, I got to thinking about taxes and stocks and refashioning losers into winners in this forgiving market. The rationale is pretty elementary. If the world is to remain more or less awash in central-bank money, and stocks seem to be key beneficiaries of this largess, it increasingly makes sense to reset position costs on stocks that might rise higher in 2015, even though they have stumbled this year.

Telecom giant AT&T (ticker: T) comes to mind as a stock that has long-term merit but has had a bad year. So does alternative investment firm KKR (KKR) and almost any other solid stock trading closer to lows than to highs and for whom 2015 is full of promise and hope.

THIS IS NOT EXCITING STUFF, but it is important because it helps investors lower their tax bills, and position themselves for gains. Each year, about now, responsible investors begin to prune their portfolios.

Bad stocks that are beyond redemption, if they have not already been sold, are jettisoned. Other stocks that disappointed, perhaps because of temporary difficulties, are subjected to tax-loss selling.

The trade is simple. You identify a fallen stock you wish to sell for a tax loss. But rather than selling it right away, you “double up” by buying more of the stock. After 31 days, you sell the first lot of stock that you bought and record a tax loss.

The 31-day lag is critical. If the stock is sold in less than 31 days, the Internal Revenue Service, which lacks an Everything’s Gonna Be Alright philosophy, will cancel the tax loss.

Selling the stock before 31 days pass violates the IRS’ “wash-sale rule.” The rule prohibits investors from realizing capital losses if they buy back a security substantially identical to the one that was sold or will be sold in less than 31 days.

If the wash-sale rule is violated, the capital loss is canceled. The last day for investors to clean up their portfolios and make tax-loss sales for 2014 is Nov. 28.

Michael Schwartz, Oppenheimer’s chief options strategist, advises clients to use calls that expire in a year or more rather than doubling up with stock. Calls cost less than stocks. The drawback with a call is that owners do not collect dividends.

SAY YOU BOUGHT KKR last January in anticipation that it would, as other financial stocks were then expected to do, rally higher amid a recovering global economy. The investment initially worked great. The stock set a 52-week high of $26.50 on Jan. 22, and then declined. On Oct. 15, the stock set a 52-week low of $18.84.

With KKR’s stock recently around $21, investors can double up with KKR’s January $22 calls that expire in 2016. The long-dated calls recently traded at $1.90.

The call option lets investors participate in any advance that the stock might experience before the call expires.

Of course, the stock price must exceed the call’s strike price for the call purchase to prove profitable. At $28, which is Oppenheimer’s price target, the call is worth $6 at expiration. If the stock stays below the strike price, investors lose their money.

Remember what Schwartz, the dean of Wall Street’s options strategists, tells his investors who come to him for help with tax-trading issues: “Take a loss, not a wash.”

Reprinted by permission of Barron's Online, © 2014 Dow Jones & Company, Inc. All Rights Reserved Worldwide.

The views expressed in the above papers and articles are solely those of the author of the article, and do not necessarily reflect the views of OIC; the information presented is not intended to constitute investment advice or recommendations to purchase or sell securities of any company; and the information presented is based upon particular events that may or may not recur in the future.

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