How Does Option Pool Work
As mentioned in my other articles, when you pool your trades together, you are creating an option pool. In a nutshell, this means that you are taking out a "security" in the form of a loan on a pre-determined amount of money that is paid back over time. This option pool is similar to borrowing against a CD or a mortgage, but instead of using interest to repay the loan, you are actually paying it back over a longer period of time. The length of time varies by the amount of money you pool with others, but if you take the time to discuss your options with a qualified broker, you should be able to get a good idea of how much you can afford to spend on your option pool.
You will find that there are a lot of benefits to be derived from investing in an option pool. For one thing, you do not have to take out a separate CD to fund this investment. It's tax-free and no matter how large the lump sum may be, you'll never have to pay capital gains tax on it. The amount is deductible for income tax purposes, which makes it even more attractive to those that don't itemize their deductions. Plus, the lump sum is usually returned to you within a year to two years, making it a low-risk, high-reward investment.
However, there are also risks that go along with using an option pool. If you are putting your money into an option and the market goes south, so does the value of the money in the option. Depending on whether you are long-term or short-term investors, this could result in a loss. If you purchase options for futures contracts, you can lose a lot of money if the price drops. If you don't think you can wait a long time for the prices to drop, don't put your money into an option pool.
Another risk is the risk of holding an option contract longer than you need it. If an option goes against you, then you have to cash it out before it expires. If you have an interest only account, then you can buy options for longer periods of time. However, you will miss out on earning interest on the money if you hold on to the option too long.
Some option pool providers extend their contracts for up to 10 years. You don't want to use this option, however, if you are planning on having your money in the money market for an extended period of time. This is because you stand to lose a lot of interest if interest rates fall. If they rise, so does the amount of your capital. You may be better off simply borrowing from a traditional bank.
You should be careful with an option pool that provides you with both the right to sell as well as purchase options. You need to ensure you can sell your option within a reasonable amount of time, otherwise, you will have lost a lot of money. Some people think they can take their money out of the money market as soon as the prices drop. This may work for a while, but you risk losing your profits if interest rates suddenly drop lower. It's better to just invest your money into some more worthy options, such as the money market itself.
When you sign up for an option pool contract, make sure you read all of the fine print. Check to see how much money is in your option and how much the actual value of the asset is. It's also a good idea to check with the provider to find out whether they have any penalty for pre-determined withdrawal. Sometimes, a provider will put a one month cap on the amount of money you can withdraw each month. It's a good idea to ask about this before signing on the dotted line. If you don't know whether you can take your money out within the month, then wait.
As mentioned before, some option pool providers only pay out when the value of the asset goes up. If you put money in, but you never get paid out, that's not going to do you much good. Be careful when considering options of this sort, and use them carefully. 409a valuation report don't want to blow your entire investment in one bad trade. With so many options out there for post cash flow investment, it's easy to see why.
