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Linn Energy, LLC (LINE) Message Board

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  • badbernanke badbernanke Nov 6, 2008 11:14 PM Flag

    Cato and Badbernanke; request for input

    It looks to me as though Cato has hit the nail on the head with correlation of price movement between LINE and EVEP and I agree that EVEP is a more actively traded MLP.

    Options . . .

    If you want perhaps more direct correlation and aren't worried about LINE going above $20 in the next 31 days, you could consider selling LINE April 2009 put contracts at a strike price of either $20 or $22.50. The $20 has a bid/ask of $5.60/$6.40, so you could perhaps get it at $6 (I use limit orders on options where they are not actively traded, which is the case with almost all MLPs). A $22.50 has a bid/ask of $7.60/$8.50, a mid point would be about $8.10.

    After the 31-day period, you could repurchase the option position and buy LINE.

    I suggest April to increase the unlikelihood that the older will exercise the option before the end of the 31 days. If that were to happen, you'd have a wash sale issue.

    Essentially, the option should track LINE's up and down movements fairly closely, but not perfectly. If LINE were to jump by $2, the put would decline in value (the cost to close the put position) in fairly close tandem -- you would have a gain on the put closely paralleling the gain in LINE units. If LINE were to decline in value, the cost to close the put would rise in fairly close tandem and you would have a loss on the put very close top the decline in LINE's market value.

    The longer the option, the more time value, since time value erodes more slowly the longer the option period, the correlation isn't perfect.

    The bid/ask spread is also a cost factor that has to be considered, but if you were to wait 60 days, for example, the time value would decline and offset some of the bid/ask spread issue. Compare Jan 09 put prices with the Apr 09 prices and you will see how the January put rices are lower by nearly $1.00 compared to the $22.50 puts due solely to time value being less on the Jan puts.

    Of course, if LINE were to have a massive price spurt and rose above the put price, you would lose the excess over the put strike price, which is why you might want to use the $22.50 strike to give yourself more upside room.

    Clear as mud? Hope it helps -- obviously, EVEP is an easier proxy to use.

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    • If you want perhaps more direct correlation and aren't worried about LINE going above $20 in the next 31 days, you could consider selling LINE April 2009 put contracts at a strike price of either $20 or $22.50. The $20 has a bid/ask of $5.60/$6.40, so you could perhaps get it at $6 (I use limit orders on options where they are not actively traded, which is the case with almost all MLPs). A $22.50 has a bid/ask of $7.60/$8.50, a mid point would be about $8.10.

      **** slight flow here **** but agree mostly here is why
      I think if you are bullish you are better off doing a buy write since with put options you would not get the dividend of $.63 and if you sell out of the money say 22.5 calls and you would pocket the premium on top of the dividend.

      • 1 Reply to alraytse111
      • Hi alraytse.

        I don't think your perceived flaw applies in this case. The suggestion was specifically addressing a question by an individual who must sell his/her units for tax reasons. Buying units and doing a covered call was not an option for wash sale reasons so option strategies were limited.

        The option strategy suggested only needs 31 days and no distribution will be declared until, at the earliest, February 2009. Plenty of time for the option strategy to work, close the option position and be long in time for the next distribution if that is the wish of the investor.

        Actually, if one has no concerns about wash sales and is bullish on unit price, there are better strategies than a straight buy-write.

    • And another point - any distributions you've received from LINE will be taxed as ordinary income when you sell while any loss will be limited to the difference between your original purchase price and sale price. Be sure to dispose of your entire interest in the MLP in order to apply any carryforward losses. Also, LINE may be passing through large Capital Gains to unitholders depending on how they treat their asset sales. However, you'll be getting those whether you sell or hold so that may not matter but it could up mess up your tax planning.

      • 1 Reply to PSHONORE
      • Good points Paul.

        Tracking cumulative reported operating losses that haven't been deducted, by each individual MLP, is important for offsetting them against distributions that would otherwise be ordinary income. Since MLP operating losses can only be offset aginst income from that same MLP, this task is important. And selling 100% of the position is the only way to get the loss carryover in play.

        To date, LINE looks to have about $1.50/unit of capital gains to pass through (assuming book and tax accounting is the same -- never a sure thing). Selling before the close of the latest sale should keep any gain on that transaction from being passed through. Of course, if oyu are like so many others, you are selling LINE at a capital loss and the capital gain pass through can be offset against capital losses.

    • One more point -- enter into the put position before you close the long LINE position since using limit prices means that the order may not be immediately filled. It is easier to get an order filled for units. But to be sure no major movement occurs, the transactions shoul dbe as close to simultaneous as possible.

 
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