Exemptions and reliefs: reliefs: Intermediary Relief - hedging
There is a degree of risk or exposure for the writer of an option as he will not generally know whether the holder will exercise the option any time within the agreed time period. Commonly, the issuer will not have the required quantity of shares in the underlying security (at the time when the option is written or during the period of the option) to satisfy or cover, say, a call option that may be exercised by the holder. These are called uncovered options.
In this situation, option writers can minimise their risk or exposure by:
- purchasing sufficient quantity of the underlying shares during the period of the option, or more frequently,
- offsetting their exposure on the written call option by, say, purchasing a call option from another exchange member.
This mechanism of minimising risk is called hedging.
A person who carries on a business of writing and dealing in options, can be relieved of Stamp Duty Reserve Tax (SDRT) charges that arise on purchases of underlying UK registered securities used to hedge options, if, and only if, the exchange member fulfils all of the conditions for stamp relief, that is, being a recognised option intermediary (FA86/S88A). The relief is restricted to the quantity of shares that is required to cover an option, with any excess quantity being considered speculative and therefore chargeable to SDRT under FA86/S87.