Mark Andraos

Concentrated Stock Positions: Ways to Reduce Single Stock Risk

A single stock can make you rich, but multiple stocks can keep you rich: Strategies to reduce your concentrated positions

 

As the equity markets continue to climb higher, individuals who hold concentrated stock positions may find themselves feeling a bit uneasy, particularly with one position becoming a much more meaningful part of their overall wealth and future financial security. Those who have been fortunate enough to achieve superior returns on a particular stock may feel hesitant to divest a portion of their concentrated position due to tax issues, loss of potential upside opportunity or simply due to sentimental reasons. However, there are certain strategies available to investors to help manage single stock risk. Here are four risk-reduction strategies to explore:

 

 

1. Collar strategy. This strategy entails simultaneously selling an upside call option and buying a downside put option. Since a put option grants the owner the right to sell a stock at a particular future price at a given time, the shares will be protected from falling below the put option’s level. Conversely, the investor caps their upside participation (the call option ceiling). This structure allows the investor to participate freely within the band of the put and call strike prices, limiting both the downside risk and upside opportunity. At maturity, the payoff of the collar depends on the market price of the stock.   

 

2. Prepaid variable forward. This strategy is an agreement to give a predetermined number of shares to a brokerage firm, with the stipulation of officially transferring title at some future date. These forward contracts are oftentimes used by investors to lock in their profits and defer taxes. In return for providing the shares to the brokerage firm, the investor typically receives 50-90% of the current market value of their shares. Since the contract establishes floor (due to an underlying collared position) and threshold prices that govern how many shares are returned at a given market price, the investor is protected on the downside while enjoying potential appreciation up to the threshold. Additionally, the investor can take the proceeds from the loan and invest into a diversified portfolio.

 

3. Pooled exchange fund. This strategy takes advantage of the fact that there are a number of investors who also have concentrated stock positions in other companies that would like to diversify as well. In a pooled exchange fund, investors pool their shares into a partnership and each investor owns a pro-rata share of the exchange fund. Diversification is accomplished because now the investor owns a share of a fund that holds multiple positions. One disadvantage is that pooled exchange funds typically have a five- or seven-year lockup period in order to satisfy the tax-deferral requirement. In addition, the investor may or may not like many of the investments that are pooled together, making the exchange fund more or less attractive than the shares you are contributing.

 

4. Sell all (or a part) of the stock outright. While this is not necessarily the most tax-efficient option, this is the simplest method of diversification. If there have been substantial capital gains accrued on the position, this may be a better option for individuals who have large capital-loss carry-forwards or those who are in a low tax bracket.

 

 

A man once said, “A single stock can make you rich, but many stocks can keep you rich.” Highly concentrated stock positions can expose an investor to significant risk exposure and these above-mentioned strategies should be explored in order to more closely match your risk tolerance with your overall goals and objectives.

 

Mark is a Portfolio Analyst at Heller Wealth Advisors. If you would like to learn more about diversifying your concentrated stock position, please contact Mark at This email address is being protected from spambots. You need JavaScript enabled to view it. . 

Strategies For Maximizing Your Lifetime Social Sec...
Last Minute Tax Tips

Heller Wealth Newsletter

*
*

Client Portal

Bio Awards

Follow Us