Hedging with Prepaid Variable Forward Contract

Prepaid variable forward contract is an agreement made with the brokerage firm by an executive of the firm to lock in the profut and defer the taxes on the capital gain. Predetermined number of shares is given to the brokerage firm, with the official transferring on some future date. In return the executive recieves usually 75%to 90% of the current value of the stock.

The original owner receives a high percentage of the value of the shares at the time of transfer and receives a portion of the gains at the official transferring. If there was a loss during this time period, the brokerage absorbs it. The investor can then use the cash advance to diversify his or her overall investment portfolio.

Options - In nutshell

Option contracts are the trade right and obligation for buyer and seller respectively on underlying asset at a pre determined price on or before the time specified in the option contract. Having said that, the buyer of the option contract acquires the right to to buy/sell the asset and the seller of the option contract is under the obligation to honour the trade if option is exercised by the owner of the option.

Underlying asset can be stocks, indices, commodity future, currency or interest rates.

Option premium is the consideration paid upfront by the option holder (buyer of the option) to the option writer (seller of the option).