20 Jan 2012, 11:59pm
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  • How to Use Sharesave Save As You Earn schemes

    For this to be any use to you you need to be a worker drone in a company that is listed on the London Stock Exchange, and has a save as you earn scheme. In practice I think that means it’s probably  a FTSE100 firm.

    The idea of sharesave is to encourage employees to take a share in the company, all considered A Good Thing. They’ve been running for years, I recall my Dad doing these. If your company offers one, they are a no brainer, do it, do it now, and do it to the max (£250 per month), as long as you don’t go into debt and have cleared your consumer debts other than mortgage. Once you have five year’s worth of contributions, you get that one way bet at no extra cost. It’s rude not to take part in an offer like that 😉

    Caveat employer… don’t hold shares in your employer longer than you need to

    You should generally avoid holding shares in your employer other than as part of sharesave or share incentive plan (another wheeze like SAYE, without the one way bet but with big tax advantages). That is because if your employer falls on hard times not only do your savings take a hit due to the share price bombing, but you are more likely to lose your job. The only exception I can think of is if you believe your employer is likely to be bought by another company, which is usually terrible news for employees but can be associated with a share price hike. It’s still a long shot and there are better ways of preparing for redundancy…

    For a similar angle but from a bunch with more financial clout than me, see the FT on will you buy into the John Lewis economy on the hazards of over-exposure to your employer. Think Northern Rock when you fancy holding onto shares in your employer longer than you have to…

    What’s so good about sharesave?

    The reason sharesave is a no brainer is that it makes you the kind of offer you will never get anywhere else, a one-way bet on shares. The worst you can do is simply end up saving cash for three or five years.

    What happens is in any year you are offered the option to buy shares in three or five years time at a price fixed at near what it is now. You start a monthly savings plan for up to £250 p.c.m. post-tax allocated in any proportion to the three and five year schemes. In five years time if the share price is higher than the option you exercise the option and then sell the shares immediately, pocketing the difference. Obviously if it’s lower you don’t exercise the option, and say I’ll have my cash back thank you very much, with some interest added usually. In a slightly depressing observation on the financial acumen of some of my workmates, I’ve known some people exercise the option when it isn’t in the money, and that’s even after the firm has added a letter to the maturity note saying you should note you can buy the shares cheaper on the open market. There’s no helping some people 😉

    In the past it was easier because you were able to drop schemes where the option price was higher than the latest offering, but HMRC has stopped that wheeze, (No, they didn’t, just some accounting changes made it so letting employees do that cost the company. See this comment for details. If your company still allows you to drop a scheme and reallaocate the savings allocation to fresh schemes, then you want to read How to Use Sharesave Redux) so though you can drop a scheme you aren’t allowed to allocate that monthly allowance to later schemes until the original term is up. This means you need to think first before acting, to avoid stiffing yourself further down the line.

    How to play sharesave to best advantage

    First you need to ask yourself realistically how long you expect to be working for this firm. If it’s only for five years then buy the three year scheme for two successive years, £125 a month in year 1 and the same amount in year two (i.e. £250 in total in year two and three, then £125 in year four). However if you are looking at working there longer, then you need a plan.

    Diversification is still your friend with sharesave, even though you are only dealing with one share. What everybody seems to miss, is that you have two temporal periods (3 and 5 years) and the chance to sample the share price every year.

    What you don’t want to do is look at the option price for the two schemes in the first year, decide the 5 year scheme is cheapest, and lob your whole £250 savings into that. You want to maximise the diversity of your time-slots.

    Diversify your temporal risk

    You also want to maximise the amount of time you’re in the market, so if you are going to be a lifer in this firm (or even aim to work there for a decade) then buy £50 of the first year’s 5yr scheme, £50 of the next years 5yr scheme, and so on. After five years, your allowance for the first year’s scheme will come free as it matures, and you can allocate that to the sixth year’s SAYE scheme. If you sell as soon as your options mature, assuming they are in the money, then you will have the cash to allocate to your next allowance, so this one-way bet is now free.

    You can do that instead with the three year scheme, but your options will only be in the market for three years rather than five, which reduces the amount of time your cash is in the market exposed to that one-way bet.

    I simulated this using the FTSE 100 index as a proxy for a typical blue-chip firm offering a sharesave scheme.

    yearly Sharesave returns if the company followed the FTSE100 index

    yearly Sharesave returns if the company followed the FTSE100 index

    and the cumulative profits over a 20 year period:

    Cumulative sharesave profits over 20 years

    Cumulative sharesave profits over 20 years

    The cumulative profits understate things because of inflation, and it also shows the heady profits that were to be had from the stock market in years gone by, the fat years after the early 90s recession up to the dot-com boom, then the 10 lean years from the dotcom bust to now…

    The pattern is familiar, I made most of the money from sharesave in the years leading to the dot com boom, and very little in the decade after. Unfortunately there was corporate action for my employer in 2001 which means I can’t get a historical time series back to 1990. The ride was a bit more choppy than this graph shows, and sadly I didn’t realise that the 5 year schemes are so much more valuable than the three, so I did a mix of 3 and 5 years.

    Watch out for specifics

    The industry your employer is in doesn’t necessarily have the same statistics as the FTSE100. It’s likely to be a damn sight more choppy – I know my company is. So it may be worth simulating the last decade or so of price data for your firm. Here is the spreadsheet I used, exported to Google docs. There may be cyclical patterns in your company’s share price that make some of the assumptions break down. Having said that I’d have done fine running rolling five years sharesaves with my employer’s shares.

    Don’t go with your gut

    I learned something from writing this post. From a gut feeling, I had gone for diversifying the period, buying a mix of 3 and five year schemes. I had not realised until now the fact that the 5 year schemes give me more time in the market and how valuable that was.

    This may have been offset by the fact that for my entire sharesave career I was able to drop previous schemes where the option price was higher, and reallocate the allowance to the more advantageous sharesave scheme. HMRC disallowed that in 2009, so you won’t be able to do that. Now if you take out a 5 year sharesave scheme even if you stop saving you can’t reallocate that allowance until the original 5 year term is up.

    Responding to exceptional share price events

    My employer had a near death experience which resulted in some pretty nasty management practices. Previously I had assumed I was going to carry on working to 60 at that time, but one particular incident showed me I was unlikely to make the course, so I switched all effort into saving up to be able to retire early. This near death experience slammed the share price in 2009, so the option price on that sharesave was very low. Though I didn’t know if I would still be working there in 2012, I dropped every single previous sharesave and threw everything into that year’s sharesave, with half the money allocated to the 3-year and half to the 5-year scheme. Obviously I have to put a lot more per month into the 3-year scheme as you only have 36 months to buy your shares, as opposed to 60 months. The aim is to have an equal monetary stake at the end. This works out to £94 in the 5-year and £156 in the three.

    The principle is that you don’t know what will happen in 3 or 5 years time, so I want to bet on both horses. Say the Euro blows this year, then the 3 year options might lapse but the price on the option maturing may be lower. In that case don’t execute the option. There’s still chance for some of the storm to blow out and the 5-year option to come good. Although I don’t expect to be working there when the 5 matures, once the scheme has been running for three years then under some of the circumstances I may leave I could make it paid up.

    If the 3 year option matured tomorrow, I would do very well out of this sharesave, indeed I couldn’t liquidate the shares without becoming liable for capital gains tax, which would be a first for me. I believe that the Euro is doomed beyond redemption, and that the denouement could very well happen this year.

    So I have gone to IG Index and shorted half the number of shares I have options in. Barmy, you might say, why the hell short something I own, but that has the effect of locking in half the options at the current price. If they go down I make a profit at IG to compensate, if they go up I have to pay IG but I get more selling the options. I’m prepared to pay that as insurance. In three month’s time I will short half the remaining half, assuming it makes sense, to lock in the price for three quarters of the shares.

    Spread betting comes with an extreme wealth warning, but it’s the right tool for the job here. Another case where you may want to short a stock you hold is to avoid eating a capital gains hit. Just carry on holding the shares and short them, buying the short and the number of shares you own / 100 (because IG prices move £1 for every penny the share price moves, with you rescale back but selling 1/100th of the amount). If nothing untoward happens I may have to do that in August; sell half the shares to avoid the CGT liability and roll over the IG short on half the total which I will still hold, eliminating my exposure to my employer without selling the entire stake.

    Spread betting works for the tax-free employee share incentive plans too. With these, you buy up to £125 of shares from pre-tax and NI income, which you have to hold for five years before you can sell.

    Sadly, this is another trick I missed, so some of the shares I hold went through the near-death experience, though they’ve come back up. I could have shorted thse guys as I bought them every month, taking the tax-free bump up and protecting my purchase against the vagaries of the stock market. However, it just goes to show one of the dirty little tricks of capitalism. By the time I got experienced enough to spot this insurance scheme, I’m about done with the opportunity to use it. As a colleague once wryly observed, money is drawn to money…

    13 Jul 2011, 8:00pm
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  • Spreadbetting Sharesave, Riding with the Devil…

    One of the benefits of working for a big FTSE100 company is they do sharesave schemes. I’ve never understood why anybody doesn’t do sharesave if they’re offered it, but less than half seem to. You get to save up to £250 a month from taxed income, and get the option to buy shares either three or five years in the future. The option price is set at the price at the start of the scheme, usually with a small discount on the current share price.

    Now these are optional options, mind you, so you don’t have to buy them at the off, but you have the right to take them. That’s not like any share options you normally buy. If the SP of your company has gone down the toilet over the 3 or 5 years, well, let the options lapse, and instead take the cash you’ve saved and go on holiday/buy a flat panel TV/stick it in an ISA/buy the shares of your company or another on the open market if you like.

    There is absolutely nothing not to like about sharesave. But what you mustn’t do with the buggers is look at the sharesave account screen and start thinking what you’ll spend the money on. Because you ain’t got it till the options mature and you take them (or not). So I keep ribbing a colleague who has already decided what he’s going to spend it on, ‘cos these suckers have got another year to run.  Believing you’ve got it now is like the poor saps that start to think about spending the winnings from their Lottery ticket before they’ve actually won them.

    The SP has gone up about three times the option price. That time two years ago was a dark day for the company. I dropped every single previously running sharesave contract to hit that one which the full £250 per month, even at the same time as I was wondering if I could stick some of the nasty practices any more. It’s not like betting on red, if I left early I collect the cash savings plan, so no big deal. Sharesave is like that, the worst that could happen is you get your money back 😉 Compared to anything else to do with shares, that’s pretty damn good.

    Don’t count your chickens…unless you can lock the suckers in

    My colleague sets me off thinking. The SP is three times higher than at the start. I would be happy with that, what if I were to lock in that price? I’ve had the prior experience of things looking great only for it all to go pear-shaped by the maturity date. Generally Joe Public can’t sell shares they haven’t got, well not for only £15k worth of shares. However, there is a shady part of the financial market called spread betting that lets mere mortals short shares. What if I use spread betting to lock in the current SP?

    My favoured financial spreadbet company is IGIndex, because I understand their system. Hey, I’ve lost money with them before 🙂 The advantage of expensive education is you get to remember what went wrong.

    I cocked up massively at an earlier date using spread betting, through coming up with some byzantine approach to try and measure the value of the SB options, and getting the tracking wrong. There was no need for all that complication. The way to look at it is I hold options on 7,535 shares. If a share moves a point it goes up by 1p. IG options go up by £1. So I need to sell 7535/100 = 75 options to cover my real holding of buy options. I then need to cover the margin.

    This sort of game sterilises a lot of cash if the SP rises a lot. I have enough to cover a fair change in the SP, and my company is an elephant, in a mature industry, so it will probably not gallop. So if I cover a 2x margin I will probably be okay. I’m only protecting 1/4 of my options to start off with, so if this elephant starts to gallop I’m still in the money (by 3/4 of what I would otherwise have gained relative to now, less the spreadbet spread). I should be so lucky. On the other hand if it tanks then I’ve locked in the tripling in value for 1/4 of the stake, minus the spreadbet spread. If I haven’t screwed up, I can’t lose, subject to the force majeure conditions later.

    The trouble with spread betting is you are dealing with spivs

    Spreadbetting isn’t real, like Contracts for Difference. Spreadbetting is effectively playing inside a model of the stockmarket set up by IG Index. It has to bear some resemblance to the stock market to be credible, but there are traps for the unwary in terms of short-term spikes and distortions at times of market stress. I need to have enough margin that for IG not to feel they could get away with forcing me out. There is no recourse or process of appeal.

    IG Index are basically spivs. The clue’s in the name – spread betting. The trouble with dealing with spivs is you get spivvy behaviour. They’re as crafty as they can be without being provably dishonest. I wasn’t aware of their fun and games with spiking people out beforehand, and as a timid spreadbetter I was tossed out on earlier forays. At an unnecessary loss, natch.

    So I’m only protecting 1/4 of my option holdings, and have a very high cash holding relative to the difference I am expecting.  That isn’t how you’re meant to use spread betting – it is sold to the impecunious as a way of leveraging up.

    That’s not true, and it fails you when you need it most, so neophyte punters get margin called and eaten for breakfast. It seems if you haven’t got a cash holding with them that would be equivalent to the cost of the equivalent shareholding on the stock market, (covering a fall to zero for call or a doubling in SP for put options) they’ll have the opportunity to close your position on spikes. I’m reducing my exposure by only covering 25% of my holdings as I can only take a position until March which I would need to rollover at some cost to get to Sept 2012.

    I will see how it goes with this before covering any more, ideally with a spreadbet reaching to September 2012 in one go. If the current spreadbet works okay for the next quarter (i.e. the change is what I expect, it doesn’t have to be positive) I will consider protecting another quarter of the holding, effectively freezing my gains progressively; pound cost averaging in reverse.

    SB firms have a bad reputation (thanks to the anon poster who educated me to this) for putting spikes in their data so people that use stop-losses get spiked out and their positions closed. So I need to take an unprotected position – I have the stock assets to cover it in my options, so the only way I get kicked out is with a margin call. I need to front load the account with enough cash to cover a notional 2x increase in SP.

    Having understood my previous cock-up and been warmed up to the shady tricks used by IG to trip up over-fearful punters with narrow margins/stoplosses I’m up for it. The fundamentals of what I’m trying to do are sound. However, it’s unusual – most spreadbetters are trying to make money from trades without underlying assets to back up the trade.

    What could go wrong? Force majeure for starters…

    If I lose my job before next August and the SP has risen I lose the options and get to eat the crow on the spreadbets. If the company takes an external unforeseen hit then the SP usually tanks, think News International. However, if the company management announce redundancies the SP usually goes up, because stock markets hate employees in the way vampires hate garlic 🙁

    Likewise if there is a bid for the company the SP goes up, though the pension scheme issues with my company probably make it toxic enough for that to be unlikely at the moment. I’m prepared to take these risks, let’s face it if redundancies are on offer then I will be first in line for voluntary redundancy The pension scheme means compulsory redundancy is expensive, the firm has never gone that way yet, though there are other ways of ejecting people without making them redundant. I’ll eat the loss on the spreadbets without too much remorse in that case.

    Dividend payments are taken from the account on the ex-dividend date for sell options. In theory this should be offset by the corresponding fall in the SP which boosts the value of the sell option. I will experience this at least once. The divi has been declared, so I know how much this is and consider this the price of insurance.

    A Faustian pact with spivs is never going to be easy

    In the end hedging is never going to be easy, it’s counter-intuitive and a spreadbet is inherently leveraged as you’re focusing on the difference in SP rather than the total SP, so it’s easy to bite off more than you can chew.  I can afford to lose the entire stake, though it won’t make my day, it would nearly wipe out my entire ISA gains this year.

    If that happens I’ll take the lesson, and actually close this spreadbetting account and accept I haven’t got the smarts to use it properly. Assuming, that is, that I don’t find out that I fundamentally failed to understand how to track my sharesave options with the spreadbet. If it’s my bad I don’t mind paying for education, though I’ve double checked this time 🙂

    I’d like to find a decent solution to the hedging conundrum. It’s particularly valuable for sharesave, and it would have been great to have found a hedging solution in years gone by. I’m also sitting on a stack of Share Incentive Plan shares which I have to hold for another four years to retain the tax advantages. It would be nice to lock these suckers into the current share price without selling and eating a 40% hit.

    Why not Contracts For Difference?

    On the face of it CFDs look like a better approach. However, I’ve opened a demo CFD account with my ISA provider, iii, and there appear to be significant commission and financing costs for a year’s worth CFD. For a short trade the finance charge seems to be in my favour, but III in their own literature say that CFDs tend to be shorter term holdings.

    Daley says that, ultimately, choosing between a CFD and a spreadbet tends to come down to personal preference: “People tend to go for one or the other. If they like CFDs, they don’t like spreadbetting, and vice versa. Overall, CFDs tend to be used for slightly shorter intra-day trading or for perhaps two to three days.”

    Plus there’s a £35 per month (!) inactivity fee on their CFD platform. So in this case it’s better the bunch of spivs that I know…

     

     

     
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