Help with building a hedged value dividend portfolio

[gescob3]

From a unique situation due to my primary work being a landlord and an S-Corp business owner I have a tremendous amount of paper losses and the ability to drop down my AGI through aggressive elective retirement funding. In short, this creates an opportunity for me to bury long term capital gains in the 0% tax bracket. For example, in 2018 tax year I completely buried a 100k long term capital gain in that 0% bracket.

For the tail end of 2018 I went long more aggressive growth stocks. When SP was at around 2875 and kept this up until April 2019 when the SP had returned to 2875. At that point, my portfolio was up 50% (400k) and I decided I more want to balance my overall risk by moving to what I saw as more defensive equities that paid dividends and also do a bit of an SPX market short.

The thinking was the bulk of my personal wealth is tied to RE in Chicago. By overall going long in equities that don't have much at all to do with RE in Chicago that could offer some balance. Instead of selling calls on my equities since I could risk unqualifying my dividends I sold 2021 Dec straddles on the SPX to hopefully provide the same volatility decrease as covered calls would. But also opening up the opportunity that if my equities dropped my SPX short would be profitable and since it is 1256 I could take the short profit at a high % of that as long term gains.

Now we are in Feb 2020, my strategy didn't go well on the equity value side. My "defensive" equities literally plummeted, while the SPX boomed delivering a double hit.

Almost all of my 400k gain was wiped out. Today I am hovering at about 20k over my Oct 2018 entry point. I did achieve some of what I sought on the 0% tax bracket.

I think where I went wrong was largely the short I chose to hedge my dividend portfolio against.

I was hoping ET community could offer up some recommendations.

Inevitably with seeking a high yielding portfolio, I do have a substantial portion in Petrochemicals. I tried my best to balance this with other sectors as well. Currently, the dividend yield on my cost basis is 10%.

 

[Specterx]

Your basic approach here is unsound in several respects. You really should not be touching options unless you trade them on a pro basis. "Hedging" a portfolio of long stocks with options does not work as a strategy - overall, the cost of the options cancels out any upside you receive from the equities. You either take the risk yourself or pay someone else a spread to take it off your hands.

The perceived safety and stability of a high-yield dividend portfolio is also illusory - a flawed concept that nonetheless draws retail investors like flies. Obviously, the market does not allow you to extract a "safe" 10% yield with 30yr rates at 2%.

Honestly, your best bet is to just run a standard passive diversified portfolio - maybe with more weight towards T-bills and international assets and less in bonds. Anything else you do is likely a -EV bet, on balance. If you're concerned that you have too much Chicago RE exposure, then sell some of it. Maybe start a side business repo'ing cars, or something else that will see a big uptick in custom if we hit a recession.

 

[Bum]

Too much focus on taxes IMO. Focus on making good investments and hope you have lots of profits to pay taxes on.

Just prior to the end of the year, if you have a large profit then look through your list of stocks and sell some with large losses that you think weren't/aren't good investments anymore. This will offset some profits. In 30 days you can re-purchase the losers you closed if you still think they're good investments.

IMO, oil and coal are poor long-term investments. You're pretty heavily weighted there. ETFs are a better choice IMO. Diversify into several sectors without picking stocks.

 

[danielc1]

Is your tax transfer limited in time?

 

[Handle123]

Hedging correctly, is like learning how to trade correctly. But unless you have well defined longer term Trading Plan, and able to read charts extremely well, options will be more of an expensive curse than an aid.

 

[ironchef]

The thinking was the bulk of my personal wealth is tied to RE in Chicago. By overall going long in equities that don't have much at all to do with RE in Chicago that could offer some balance. Instead of selling calls on my equities since I could risk unqualifying my dividends I sold 2021 Dec straddles on the SPX to hopefully provide the same volatility decrease as covered calls would. But also opening up the opportunity that if my equities dropped my SPX short would be profitable and since it is 1256 I could take the short profit at a high % of that as long term gains.

Now we are in Feb 2020, my strategy didn't go well on the equity value side. My "defensive" equities literally plummeted, while the SPX boomed delivering a double hit.

The experts gave you great advices.

My question is who taught you to sell a straddle on SPX to hedge your equity? If I want to hedge my profitable underlying, I execute a collar on it.

 

[gescob3]

I'm not sure if I made it clear with my initial description. The whole premise of what I am doing is largely to not have all my personal net worth in one bucket Chicago RE. The secondary goal is to create long gains that I can take in at 0% tax value. Of everything I am doing I would say that this is the cleanest most straightforward savings I can reap since it is based on a gov policy.

I wouldn't say that I saw inherently dividend stocks as safer, but the energy, telecom, banking sectors as more defensive than I previously had invested in which was largely the RV sector and a specific Biotech. The dividend play is more about taxation and the shift in sectors is more about offsetting risk of a US economic downturn.

I am happy with my overall setup, but feel my selection of using the SPX is where I went wrong. I didn't anticipate that my "traditionally" defensive sectors could fall 12% while the S&P rose 20%. The extremeness of the divergence is where the pain was. My personal decline was lessened significantly by theta decay in the short options and dividend payments along the way from the equities.

My assumption is that ultimately my positions are smaller cap which seems to have diverged more and more from large-cap. Does anyone have any recommendations on smaller cap 1256 indexes that might be better suited?

To address the question of why I didn't do a collar. If the stock had risen to exceed the sold call the dividends wouldn't be qualified.

I realized I also made a mistake in what I posted previously, I had %s with respect to my basis but not the current value. Really the bulk of my losses are related to my long coal value position, long LNG shipping and my SPX short.

Below is current market value makeup.

 

[gescob3]

The experts gave you great advices.

My question is who taught you to sell a straddle on SPX to hedge your equity? If I want to hedge my profitable underlying, I execute a collar on it.

My underlying wasn't nor did it need to be profitable. The hedge was more to address volatility as well as some way to come out on top if the market tanked.

 

[ironchef]

My underlying wasn't nor did it need to be profitable. The hedge was more to address volatility as well as some way to come out on top if the market tanked.

I thought when you made $400K last year, you wanted to protect that gain instead of giving it all up this year?

 

[gescob3]

Yes my account was up 400k, at its peak in April of 2019 so a very short time from when I entered in Oct of 18. My goal wasn't trying to ironclad protect that gain per say, but overall create a steady stream of around 100k/yr in capital gains.

I have very complex tax returns, in short I have had a negative rate for several years now. If I took a 400k gain all at once it isn't just the taxes I would pay on that gain, but it would also negatively hurt me on a lot of other mechanisms I have going on. I can handle a trickle just not a windfall.

I had an audit this year where the IRS made a mistake a number on a calculation and I needed something to be exactly below a very specific number to avoid a lot of phase outs. The difference in $200 in income swung me from a 5k to refund to owing 6k in taxes. In the end once I had someone from the IRS on the phone they corrected the mistake within 24hrs and then I got my refund.

My overall thinking was to have a long equity position that generates qualified dividend capital gains and short 1256 contract position that I assumed would move in the opposite general direction of my long equity. Back in April when the SPX was at 2875 I decided to do a long term short SPX LEAP structure where my break-even would be at 3750 by Dec 2021. Anything below that I would make some pretty substantial profits. My safety against the SPX rise would be my long equity position. I don't think the premise was flawed just my chose index hedge didn't move with my smaller cap value portfolio.

I was wondering if someone might have a better idea of 1256 index to use instead of SPX.