How to engage the strategy:
Day 1:
Sell losing stock, and simultaneously purchase replicating portfolio which mimics the performance of the stock just sold.
Day 31:
Unwind replicating portfolio, and re-establish long position in losing stock. It is very important to unwind this trade on Day 31, or later.
How to purchase replicating portfolio:
We shall refer to the table below for this illustrative example. Investor has a position of 1,000 shares of Kellog (K). It has performed poorly in 2009–down 41% as of 12/18. On Day 1 (12/21/09, in our example), Investor sells her 1,000 shares of Kellog. At the same time, a position is established in the replicating portfolio consisting of shares of PG and SWY. The hedge ratio, or Coef1, for PG is 0.58. Investor buys 580 (.58 x 1,000) shares of PG. Investor also buys 390 (.39 x 1,000) shares of SWY at the same time. SWY’s hedge ratio, or Coef2, is 0.39.
On Day 31 (1/29/10), or later: Investor sells her 580 shares of PG and 390 shares of SWY, and re-buys the 1,000 shares of K. The unwind trades for PG and SWY create short-term capital gains or losses, but no wash sale has occurred for K, and K’s losses are good to offset any gains in 2009.
To view a chart of a stock’s recent performance versus its replicating hedge click on its ticker on the strategy page. A three month history is displayed. Sample chart is shown below. Additional information is also available on the drill down page.
Replication Portfolio Performance (Kellog)
Please seek independent advice on the efficacy of this strategy from a a tax lawyer or accountant before enacting this strategy on your own.
