Two problems with buying puts as a hedge
(1) Taxes are f*ed up.
First of all, puts are in some sense considered to be short sales; any gains you have on a put are always short-term gain and thus taxed at your full marginal rate.
Secondly, there are various nasty provisions that come into play if you buy a put against stock you own:
(a) The Straddle Rules --
Any time you have offsetting positions in the same underlying stock (long stock + long put definitely counts here) you have a (tax) "straddle" --- not to be confused with the put+call notion of "straddle" that the option boys talk about. There are two provisions
o Loss Deferral Rules - if you lose money on the put, you can't realize that loss until you sell the stock; if you lose money on the stock, you can't realize that loss until you sell/exercise the put. And in either case if you sell something and buy it back again in less than 30 days, then you get hit by the "modified wash sale" rule and have to wait until you sell whatever it was you bought back before you can declare any losses...
o Holding Period Rules -- if you buy a put while you hold short term (< 1 year) stock, the holding period on the stock is terminated, meaning if, e.g., you held the stock for 364 days and then bought a put, you are SOL and have to wait a whole year after you sell/exercise the put before you can sell the stock and have it be treated as long term gain/loss.
(b) The constructive sale rule --
Here, idea is that if you own stock that has gain on it and you do a short sale of that same security, They will count that as if you had sold the stock you owned --- meaning you have to declare the gain and pay tax on it. In theory, this should also apply to selling calls or buying puts with the same underlying --- the intent of the law is that anything you do to reduce your risk and your potential gain can trigger the constructive sale rule.
However, since this law was only passed in 1997 and the IRS has yet to issue clarifying regulations, nobody knows for sure...
(2) Whenever you buy options (puts or calls), part of your premium goes into "time value" which decays; unless the stock actually moves in the direction you're expecting, it's essentially money thrown away --- which is fine for insurance, but then you have to realize that time value varies with volatility, so you're going to be paying out a lot if you try to do this with, say, Yahoo...
Edit - feel free to add/correct anything to my current understanding of the &*#$( tax code |
