Tax optimization using futures

You are comparing apples with oranges here mate.

The equivalent would be either holding 80k in SMI ETF and no cash or 80k cash + a futures contract offering 80k exposure to the SMI. And the result in these two scenarios would be the same.

Ah, right. B/c futures on an underlying require little initial margin.

My points concerning the risk profile and that you would not harvest the same return as the underlying, stand.

They most certainly do not. The futures contract will give you exactly the performance of the underlying (before trading fees).

Assuming that people are well informed and since stock indices tend to go up, why would the short holding party non consider this fact when pricing the future?

Are there reasonably good proofs for your statement, real-world? Mine is just economic thinking, but then again, I do not intend to invest my money.

There is of course data on these futures contracts. The performance of the derivatives is not the key aspect of this threat anyways.
I understand that many people have aversions against derivatives, and probably rightfuly so since they can be rather dangerous for the less informed/experienced investors.

Thank you all for your valuable inputs on the topic! If anyone has firsthand experience with the classificationas a “professional trader” by the authorities because of the use of derivatives I would be very much interested to hear from them.

Cheers
Mr.Money

The underlying idea of converting taxable dividends into non-taxable capital gains (in Switzerland at least) has merit. As pointed out there are potential issues with being classified as a professional trader in Switzerland. However, leaving that point aside there’s a more fundamental reason why this isn’t likely to be a good idea in relation to Swiss shares. And that reason is that the futures will be priced assuming approximately 65% of the gross dividend not 100%. i.e. the capital gain baked into the future will be close to 65% of the dividend amounts not 100%.

To explain. Finance 101 is that the price of a future is the current stock price - finance costs + expected dividends.

In the real world futures are priced like this but you use real world financial institution costs and dividends. i.e. a bank’s actual finance costs + some sort of margin and the actual NET dividends the bank will receive. Due to the approach of the Swiss tax authorities, financial institutions participating in providing liquidity into futures markets for Swiss Shares generally expect to receive only 65% of dividends (with no ability to reclaim any of that back).

For other markets this is a good idea in theory. In a market where the withholding tax rate is say 15% higher rate tax payers would be better off getting 85 cents in the dollar as capital gains than 100 cents in the dollar as taxable income. However, to get access to this you need a derivative. A future is the obvious choice but unfortunately I think the professional trader consequences loom too large. A product that should exist is longer term derivatives. I don’t, however, think any such product exists in Switzerland at least not a cost that would make sense. If you find longer term derivatives at low cost in other markets let me know.

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For my education: Would an expectation as to the stock price at the future date not also be included?

Also, the mentionned fees - those come on top of the purchase price for the future?

Stock price expectations aren’t included in the future price. The formula I’ve given is theoretical but reality is very close due to arbitrage opportunities. Continuing finance 101 if the futures price differs by more than transaction costs from this theoretical price then financial intermediaries enter the market to earn profits. Eg if the price of the future is too high then bank trading desks sell/short the future and simultaneously buy stocks/borrow money to hedge the position. When the price of the future is lower than the theoretical level they can lock in some (more or less) risk free profits as the bank can deliver the stocks it bought at the lower price at maturity into the future at a price that is higher than the banks net holding costs (namely finance costs less dividends received). Because of this arbitrage opportunity that prices stay very close to theoretical levels.

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Good Points, thank you for your post Gaga. I am aware of the theoretical backgrounds. Really appreciated the practical aspects of your posts though. I saw in the data, that the dividends are not priced in at a 100%… another interesting aspect you also touched on is the one about financing rates… currently the short term riskless rate is negative and this is priced into the futures. I.e. when you borrow money for your future stock purchases, you can do so at negative rate (financial futures are in backwardation).

So if it wasnßt for the “professional trader problem”, futures would be very interesting at the moment.

Hi Gaga,

Thanks for the explanation.

So in the case of Mr.Money (a non-swiss resident) the strategy isn’t worthwhile as the withholding tax is already priced into the SMI futures and other swiss indices. Wouldn’t that offer an arbitrage opportunity for swiss residents though? Sell futures and buy the underlying during dividend season? Probably not very interesting absolute yields but possibly interesting in this low rate environment.

More importantly the future strategy is probably interesting for swiss residents still (as long as the professional trader denomination is avoided), isn’t it? I.e. roll the futures rather than own the ETFs (with the exception of the swiss market ETFs obviously for the reason you highlighted above).

Thanks

Yes is would offer an arbitrage opportunity exactly as you describe were it not for the fact that the Swiss tax authorities regard this as a tax avoidance scheme and will not reimburse the withholding tax if they are aware your position is hedged (I doubt the arbitrage would be profitable/sufficiently profitable at retail transaction costs/prices even without the tax avoidance problem).

I think that is probably right although I have never checked the pricing to confirm it works in practice given the professional trader problem.

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