Variable Paid Forwards

Uhni (Ultra High Network Individual) of LiveJournal has a great post on VPFs. I had to read it about 5 times before I got the hang of it.

If you have a million dollars worth of stock and want to sell a portion to use the money, you can implement a VPF to defer any taxes. Its pretty complex so grab a strong cup of joe before you start.[and a bottle of asprin].

One interesting tool made available to high net worth individuals is called a Variable Paid Forward, or VPF. Their intended use is to take cash out of your current investment that for some reason you may not want to sell right away.

The way they work is to use a collar options strategy to guarantee a future value of the investment. Since the value is guaranteed, the brokerage is comfortable loaning you the equivalent present value at a risk-free interest rate.

A collar means that you’re buying a protective put, which protects your investment against future loss. You are buying this insurance, and to offset the cost, you can write a call option, which puts a maximum price at which you can sell. In effect, for roughly no cost other than fees, you’re guaranteeing that your investment won’t lose value; however, if it goes above the maximum price set by the call, you miss out on those gains.

Because you’re guaranteed that your investment has a minimum future value, there is no risk that you won’t be able to pay off a loan at that amount. Since there is no risk, the interest rate on the loan should have no risk premium; it is a risk-free interest rate.

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