As a business owner, you are well aware of the difference between revenue and profit. But there is a third category of wealth that can keep you up at night: paper wealth.
Let’s dive into a real-time case study, names changed.
Art, owner of Art’s Intelligence, Inc. (AII), based in Raleigh, NC, is fortunate enough to hold a pre-IPO investment in the AI hyper-scaler Anthropic (ANT). With estimates of its IPO valuation currently going through the press, Art’s likely to be sitting on a handsome 5x gain, on paper. He’s bullish on AI but, as a seasoned investor, worried about a few things:
The weight of his ANT position has become too big, and, hence, too risky, for a single investment inside his diversified portfolio.
He remembers the dot-com bubble and is asking himself: “will the stock market run on AI stocks of the last few years abruptly end soon?”
Due to contractual commitments, he can't sell or use options or the like to hedge the value of his ANT shares within 6 months of the IPO.
In other words, Art is concerned that he'll be watching his 5-fold win melt away.
Witnessing paper gains float away is arguably the most painful experience for any investor. He knows this.
So what to do if he can't sell, reduce, or hedge his position yet because his position is restricted?
Here is where a specialized institutional playbook known as cross-hedging comes into play.
Why You Can’t Just Buy Direct Put Options
When a company goes public, early investors must sign a Market Standoff or Lockup Agreement. This contract typically lasts 180 days. What many investors don't realize is that these contracts are incredibly strict.
They don't just ban selling your shares on the market; they explicitly ban you from buying put options, shorting the ticker, or entering into any private swap agreement that alters your economic risk of ownership.
If you attempt to hedge your ANT shares directly, you face severe breach-of-contract penalties, potential asset freezes from the underwriters, and massive regulatory scrutiny.
So, how do you protect a multi-million-dollar paper win when you are contractually locked in place? You shift your focus away from Anthropic itself and look at the massive public companies whose stock price can be expected to be highly correlated to ANT.
Introducing the Cross-Hedge Matrix
Cross-hedging means you leave your restricted ANT shares completely alone, respecting your contractual duties. Instead, you build a synthetic, protective shield in a separate public brokerage account using highly liquid, publicly traded proxies that are expected to move in close correlation with the broader AI sector.
Think of it like a commercial airline trying to protect itself from skyrocketing fuel costs over the next six months. If the airline isn’t able to buy a direct, legally binding contract that guarantees the exact pump price at their specific airport terminals, they can buy crude oil futures contracts at the New York Mercantile Exchange. While they aren't trading the exact jet fuel they put in their planes, the two assets are so deeply correlated that the cash profits from the crude oil contracts perfectly neutralize the rising operational costs of flying their planes.
For an Anthropic exposure, we look at the primary tech giants anchoring its ecosystem and some of whom are early investors in ANT, too: Amazon (AMZN), Alphabet (GOOGL), and Nvidia (NVDA) alongside market benchmarks like the Nasdaq-100 (QQQ). If the AI trade deflates or further interest rate hikes by the Fed make valuation multiples shrink, pulling ANT’s price down with it, these likely correlated proxies will probably drop alongside it.
By structuring option strategies on these public stocks, Art can neutralize a potential drawdown on his ANT position without incurring upfront expenses.
Let’s look at a couple of them.
Strategy 1: The Standard Collar
The cleanest way to build this shield is through a traditional zero-cost collar. Let's look at how we would apply this to a proxy like Alphabet (GOOGL) or Nvidia (NVDA).
With a standard collar, you simultaneously enter into two option contracts:
Buy a Protective Put: You purchase a put option below the current market price (e.g., 12% out-of-the-money). This establishes a solid floor. If Google drops 15%, 30%, or 50%, your put option surges in value, capturing that downside below -12% completely at maturity.
Sell an Upside Call: To avoid shelling out cash for that insurance (Put options are often referred to as insurance), you sell a call option above the current price (e.g., 10% out-of-the-money). The premium you collect from selling the call completely covers the cost of buying the put.
The downside protection is completely uncapped. If a major technological disruption or a broader market shock triggers a massive drop, the protective put possesses neutralization power, meaning it gains more value the deeper the stock falls. It acts as an absolute safety net.
Strategy 2: The 3-Way Premium-Harvesting Structure
For other proxies where you have different structural risk parameters, we can implement an advanced structure known as a 3-way options overlay. This can be highly effective for a proxy like Amazon (AMZN), which features a diversified business model consisting of cloud computing as well as being an online retail behemoth.
The 3-way structure builds on the collar structure from above. We simply add a third leg to it:
You buy an 8% protective put.
You sell the 10% upside call to fund it.
You sell a deep "sub-floor" put at 25% out-of-the-money.
By selling that deep downside put, you are harvesting extra options premium from the market. You are essentially selling “disaster insurance” for AMZN to other investors, collect the cash, and use it to completely offset your hedging costs while locking in a better strike price for the protective put.
The trade-off is that your protection is limited. You are perfectly insulated if Amazon drops anywhere between 8% and 25%. Downside risk only re-opens if a catastrophic event in the economy or the company drives the stock down past that 25% mark. It is a highly efficient structure when backed by an asset with a steady retail valuation floor.
The Risk Warnings: Basis Risk and the IRS Tax Trap
While cross-hedging is a brilliant tool for an entrepreneur like Art looking to protect his concentrated pre-IPO position, it is an advanced strategy that demands institutional precision. It introduces two major risks:
Basis Risk: This occurs if the public proxies deviate too strongly from your restricted ANT stock. For example, if Anthropic experiences a company-specific issue, its stock price might fall, making your position suffer. But if Amazon or Google simultaneously beat market expectations their value could surge, causing the option contracts to rack up potentially unlimited losses. Managing this requires financial strength and dividing Art’s hedge across a diversified basket of proxies to smooth out individual corporate idiosyncrasies.
IRC §1092 Straddle Rules: The IRS watches hedging closely. If Art’s choices of proxies are deemed to have a "substantial overlap" with his ANT position, the IRS can classify the setup as a tax straddle. This is unlikely but not impossible and may cause Art’s long-term capital gains holding period turning into an expensive ordinary income situation.
Bringing Institutional Expertise to Your Wealth Plan
Constructing a resilient multi-asset portfolio isn't about chasing hot stocks or trend-hopping. True wealth preservation requires a disciplined approach to asset allocation, asset location, and appropriate risk mitigation.
Having spent parts of my career structuring complex derivatives and managing clients’ market risk within institutional equity derivatives sales (Morgan Stanley) and capital market sales for SMEs (Deutsche Bank et al), I founded Pine Ridge Wealth to serve as a fee-only, un-conflicted fiduciary partner for people navigating these exact high-stakes liquidity events.
If you are holding a concentrated pre-IPO position, celebrating a milestone revenue year, or facing a high capital gains or depreciation recapture situation, let's talk.
You can view my live calendar and schedule a confidential, no-obligation conversation directly at the Pine Ridge Wealth Consultation Scheduler.
Have a great rest of your week,
Cristof Ensslin
Fiduciary Wealth Advisor, Owner
Pine Ridge Wealth LLC
Financial Planning | Investment Advisory | Wealth Management
Important Disclosures & Disclaimer
Pine Ridge Wealth LLC is a Registered Investment Adviser in the State of North Carolina. Content in this newsletter is provided for US readers only and is strictly for educational, informational, and illustrative purposes and does not constitute individualized investment, tax, legal, or financial advice. Investing in public and private securities involves a high degree of risk, including the potential loss of principal capital. Past performance is never a guarantee of future market results. Always consult your financial advisor before making an investment-related decision.
The advanced options configurations discussed in this case study are highly complex financial instruments. Derivative trading involves unique risks, including liquidity constraints, volatility magnification, decay factors, and counterparty or basis risk. These strategies are not suitable for all investors. Executing cross-hedges requires meticulous quantitative modeling and active monitoring; improper execution can result in substantial financial losses that may not be offset by appreciation in the underlying asset.
Tax laws governing derivatives are highly intricate and subject to varying interpretation by regulatory bodies. The tax implications of any hedging strategy depend entirely on an individual’s unique financial situation, asset location, and holding periods. Readers are strongly urged to consult with a qualified, independent Certified Public Accountant (CPA) or tax attorney prior to implementing any transaction described herein. Pine Ridge Wealth LLC does not practice law or provide formal tax advice.