Pawleys Binary Event Trade

Last week, a client asked us to review the choices within her 401(k) plan at work to identify the best investments available.  The line-up included 9 different funds and also company stock.  There is a pending buy-out of the company, so when we initiated the review of the stock we anticipated that the stock would be trading at parity with the buy-out price.  The buy-out offer contains a combination of cash and shares of stock in the acquiring company.  The board of directors and shareholders of both companies have already approved the transaction, which is scheduled to close in the next several months.

Much to our surprise, the company stock of our client is trading at a 35% discount to the buy-out level.  Clearly, the market does not believe the transaction will complete.  The merger is being reviewed by the Department of Justice for anti-trust issues.  Recently, several high-profile mergers have fallen apart amidst government anti-trust concerns, including Office Depot & Staples, Sysco & U.S. Foods, and Halliburton & Baker Hughes.  We classify a pending buy-out which may be blocked as a binary event.  There are only 2 possible outcomes: either the companies will merge, or they will not.  Let’s be clear before we continue the story – the client was not in possession of material non-public information, and the trading window on the company stock for employees was open.

Typically, the best way to participate in a binary event is to place a straddle with option contracts.  This position is constituted by calls and puts with the same strike price and expiration date (which in this case would be just past the scheduled close date of the merger).  If the deal falls through and the stock falls or if the deal closes and the stock rises, the straddle holder profits.  Philosophically, we do not advocate the use of derivatives, so what did Pawleys recommend to the client?

As we reviewed the stock, we like their fundamental financials and the valuation of the stock, and were happy to recommend a long position to the client regardless of the outcome of the pending merger.  But what if the client is not confident and wants to enter with a more conservative strategy?  The client commits an amount of cash to the strategy and we use 50% of the cash to buy the stock.  If the deal closes, our profit is limited since we did not initially invest the full amount of cash.  But if the deal falls through, we take the remaining cash to add to the long position, averaging down the cost basis, and hold the stock.  This is how Pawleys trades a binary event in a more conservative way.  Ultimately, we went all-in as we feel the stock is high-quality and want to own it even if the deal fails.

© 2016 Pawleys Investment Advisors, LLC. All rights reserved.


What’s the Real Deal with Robo?

Have you heard all the buzz about Robo Advisors?  What in the world is a Robo Advisor?  The real short, simple answer is that they are shiney, repackaged wire-house  managed accounts that have algorithms rebalancing the portfolios as opposed to human beings.   Bear in mind, humans write those algorithms.  The technology enables investors to participate with lower account minimums and very low costs.  As with all investment solutions, they should be evaluated by their after-cost performance relative to the most similar benchmark.  Awesome technology combined with a professional is a great way to work towards financial goals!  I was going to bring this Robo Advisor back with me to the beaches of Pawleys Island, but he was afraid the sand would clog up his hinged joints!  We’ll just have to continue to work together virtually.


© 2016 Pawleys Investment Advisors, LLC. All rights reserved.

Beware Rollovers!

Imagine this – after years of working for the same company, you have finally reached the time to retire.  You have worked hard to build your nest egg, and move your 401(k) balance to an IRA at an insurance company.  After a few years of mediocre performance in an annuity, you decide to move the IRA to one of the big, chain brokerage firms to be managed.  Suddenly,  you realize your new financial advisor neglected to ask one small question, and all of sudden the entire balance of your $1 million IRA becomes taxable.  Keep reading, because this happens too often.  Although asset management is my main “wheelhouse” skill, I maintain the College for Financial Planning CRPC designation (Chartered Retirement Planning Counselor).  This is the most important training I receive every two years.  The Department of Labor and the Internal Revenue Service have detailed, ever-changing, and yes, onerous, rules that must be followed regarding retirement plans and IRA’s.  When the rules are broken, there are stiff penalties and fines.  So what happened to your IRA?

In 2014, the IRS changed the rules which permit IRA rollovers.  In the past, the rule permitted one rollover per account.  Now, the IRS limits everyone to one rollover per year regardless of how many accounts you have.  Earlier in the year, you moved a different IRA from your local bank to one of the discount brokerage firms.  The bank mailed the check to you, and in turn you wrote a check to your new brokerage firm to be deposited into your new IRA.  Since your new advisor at the big chain failed to ask if you had rolled over any other accounts earlier in the year, your $1 million IRA no longer exists, and you now owe tax on $1 million.  Adding insult to injury, there may be penalties depending on your age.  There is no fix.  If you try to move the money into an IRA anyway, they will still get you (see below).  If your new advisor knew what he was doing, he could have avoided the situation by completing the transfer from the annuity company as a direct trustee-trustee transfer.  But in his excitement, he did not.  Many do-it-yourself investors who are unaware of the rules have fallen into the same trap.

Let’s no sugar-coat it, this is from the IRS website:

Tax consequences of the one-rollover-per-year limit

Beginning in 2015, if you receive a distribution from an IRA of previously untaxed amounts:

  • you must include the amounts in gross income if you made an IRA-to-IRA rollover in the preceding 12 months, and
  • you may be subject to the 10% early withdrawal tax on the amounts you include in gross income.

Additionally, if you pay the distributed amounts into another (or the same) IRA, the amounts may be:

At Pawleys Investment Advisors, we do not advocate rollovers, and encourage all clients to move assets as a direct “trustee-to-trustee” transfer.  As an example, if I moved my old IRA from the bank to my Charles Schwab IRA, I would ask the bank to make the check payable as follows: “Charles Schwab for benefit of Kathryn Schwartz IRA.”  I would also ask them to mail the check directly to Schwab.  Depending on the financial institution you may be required to obtain a Signature Guarantee, but it is worth the extra time and effort.  See the full rules below, and e-mail us with any questions!  Also, be sure you have a really great CPA to help you navigate these issues.

© 2015-2016 Pawleys Investment Advisors, LLC. All rights reserved.