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Cut Your Tax Bill by Doing This. Hurry, the Window Closes Soon.

Few investors truly understand options, which means that put and call trading patterns are cited whenever some pundit needs a fancy reason to explain why stocks rallied or declined. The more opaque the stock market appears, the truer it is.

Some market observers recently noted a big increase in bullish call volume that supposedly means institutional investors aggressively bought stocks, signaling the end of the
S&P 500 index
‘s October swoon. Others noted lots of defensive put buying, suggesting often-wrong amateurs hedged stocks when they should have bought.

Our conclusion is more nuanced. The call buying means the stock rally surprised many bearish investors. They bought calls to avoid getting crushed in case the rally meant a major market change had occurred.

The put trading probably means that investors—big and small—used the implied volatility collapse that accompanied the stock rally to hedge should the rally prove temporary. The put buying was denominated in small batches of contracts, some noted, but trading desks often trim big orders into small chunks to ease executions.

So, what should investors do now?

Embrace conservative strategies until the world is less chaotic. Don’t chase risk when major wars could erupt in the Middle East and Europe, and perhaps Asia.

After all, Warren Buffett, one of the world’s most consistently successful investors, has a huge cash position—indicating that he sees little worth buying. We think that fact is more important, if a lot less salacious, than most options-trading analysis.

As pundits debate whether or not the bull market has resumed, it’s an opportunity for you to reduce your tax bill.

Each year, the Internal Revenue Service lets investors use a strategy to realize investment losses without losing control of the stock position. This is important for anyone who bought stocks at higher prices, only to lose money. Sell a losing stock position and wait 31 days to buy the equivalent number of shares, while using the loss to offset gains elsewhere in your portfolio.

This classic double-up strategy is designed to replace stock with stock, but given the high yields now available in short-term Treasury funds, investors should consider using call options instead of buying back shares of the same company.

Consider
Bank of America
(ticker: BAC), a longtime favorite of this column. The stock is down some 15% this year, compared with a 15% gain for the S&P 500.

Investors worry that higher interest rates will severely crimp the bank’s profitability. Despite that real risk, the bank is very well run and refrains from taking big risks. Buffett—the most quoted and least emulated investor on the planet—also owns a load of BofA stock.

Investors who bought BofA earlier at higher prices could sell the stock and buy the equivalent number of call options to replace the position instead of BofA shares.

With BofA stock at $28, investors can sell the stock and then wait for the 30-day wash-sale period to pass. If you replace the BofA stock with either BofA stock or calls before 30 days have passed, the IRS won’t let you realize the tax loss. Nov. 28 is the deadline for using this strategy this year.

Michael Schwartz, Oppenheimer’s chief options strategist, advised his firm’s clients to buy BofA’s January $28 calls that expire in 2025 for about $3.75. If the stock is at $38 at expiration, the call is worth $10.

The money saved buying calls, rather than stock, can be deposited into a short-term U.S. Treasury bond fund that pays about 5% or more. “This is the first time in ages that investors have been paid to own cash and still participate in a stock’s potential upside,” Schwartz tells Barron’s.

This approach will never generate the type of buzzy options arcana that seems imbued with deep meaning, but successful investing is more about endurance and risk management than sounding clever.

Email: [email protected]

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