Tax-loss harvesting can help an options trader identify their next put option
Mid November is about the time investors start thinking about end of year tax strategies to optimize their portfolios. Tax-loss harvesting is a strategy where investors sell assets that have declined in value to realize a loss. This loss can then be used to offset gains from other investments, which can help lower their overall tax bill. With the rise fintech and the lowering of trading costs, tax-loss harvesting is becoming more common. If this strategy is prevalent enough, we should be able to detect it in the data. And if we can do that, we could use that information to help with our trading.
Tax-Loss Harvesting Context: Is it Real?
Looking for evidence of tax-loss harvesting, I analyzed the year-to-date returns of S&P 500 Index (SPX) stocks through November 15 for each of the past three years. I then grouped the stocks based on these year-to-date (YTD) returns and summarized their performance for the rest of the year within each group. The table below displays the results. Evidence of tax-loss harvesting would be for stocks that have declined year-to-date at this point, showing underperformance for the rest of year, as investors sell off these stocks to realize losses.
In the table below, I colored the most bearish value red and most bullish value green for each column. The stocks that performed the worst for the rest of the year were those that were down the most on the year through November 15. It was the worst group by far with those stocks averaging a loss of 1.6%, and just 39% of them positive. For all stocks over this period, they averaged a 2.2% gain with 60% positive. There are a lot of variables involved in stock market returns, but tax-loss harvesting appears to be one of them.
Stocks Ripe for Tax-Loss Harvesting
Below is a list of S&P 500 stocks down 25% or more so far this year. Based on the analysis above, these stocks have an increased chance of underperforming for the rest of the year. If I were looking to purchase one of these beaten down stocks, I might wait until after the new year. If I was looking to sell these, maybe for tax-loss harvesting myself, right now would be the time to do it before they decline more. For option traders, this might be one driver (hopefully, not the only driver, though) for buying a put option. Also, consider other variables. For example, if a stock pays a healthy dividend, investors may be holding it for income, making it less likely to be sold for tax purposes.
